High dividend ASX shares can provide you with a second income stream via your portfolio. Companies that pay reliable dividends tend to be established companies in mature industries.
Here we run through 2 metrics that can help you identify high dividend ASX shares.
Dividend yield
A company's dividend yield is its annual dividend divided by the share price. It represents the dividend-only return on a share investment. When dividends remain the same, the dividend yield on a share will rise when the share price falls and fall when the share price rises.
Traditionally, early stage companies and those in growth phases have tended to have low dividend yields. When companies pay out profits as dividends to shareholders, these funds cannot then be reinvested by the company to spur future growth. Mature, lower growth companies tend to pay out a higher proportion of profits to shareholders, therefore have higher dividend yields.
Dividend yields are important to investors who rely on shares for income, but are not static – yields may appear attractively high due to falling share prices. Companies can also cut their dividends, as Westpac Banking Corp (ASX: WBC) and National Australia Bank Ltd (ASX: NAB) both did last year.
Payout ratio
A company's payout ratio shows the percentage of a company's earnings that are paid out to shareholders as dividends. It is calculated by dividing the total dividends paid over a period by the company's earnings over that period. The payout ratio can indicate how sustainable a company's dividend payments are.
A low payout ratio indicates that a company is reinvesting most of its earnings into its business to spur future growth. A high payout ratio indicates that the opposite is true; if the ratio is higher than 100%, the company is paying more dividends than it is earning.
Different industries tend to have different payout ratios. Defensive industries with stable income flows such as telecommunications, utilities and consumer staples tend to have higher payout ratios. Industries with fluctuating cash flows or in cyclical sectors such as resources tend to have lower payout ratios.
Some companies set target payout ratios. Coles Group Ltd (ASX: COL) which operates in the consumer staples sector has a target payout ratio of 80–90%. AGL Energy Limited (ASX: AGL) which operates in the utilities sector has a target payout ratio of 75%.
Foolish takeaway
Used wisely, financial metrics can give useful insights into potential share market investments. These 2 metrics can indicate ASX shares with the potential for high dividends.
