That's all there is to it.  You've just learned one of the most useful tools to determine how safe your dividends are.

     What's the Optimal Payout Ratio?

     Now that you know how to calculate payout ratio, it's a good idea to consider what the ideal payout ratio is.  As is the case with most financial yardsticks, however, there is no hard-and-fast answer to that question.  Payout ratio is like temperature: What might please one investor won't suit another, and you have to go with what you're comfortable with.

     Usually, investors' first reaction to the payout ratio is to conclude that the higher the ratio, the better the dividend.  That's perfectly natural. After all, who wants to leave money on the table?  But while everyone likes to earn the greatest return possible, a 100% payout isn't the best practice, as the company will need some of that cash to operate. What's more, it might be wise to keep a little cash on hand in case an opportunity, such as an acquisition, presents itself.

     It's also prudent for a company to allow itself some dividend breathing room.  If it commits to a high dividend and business conditions change, the company might find itself in a position where it has no choice but to cut the dividend.  Certainly many companies have been finding themselves facing exactly that situation.

     Still, a relatively low payout ratio -- say, less than 50% -- might point to a company with a tepid commitment to its shareholders, or one with some sort of need for the cash it generates.  Absent a strong yield, the serious income investor generally looks past these shares. The best of both worlds, of course, is a strong yield and a low payout ratio.

     A Tale of Two Payouts

     Take Pfizer. The drug maker, which has never cut its dividend, must come up with $2.13 billion in cash every 90 days to pay it.  That's a million dollars an hour.  Pfizer, as we calculated, is paying out almost all of its earnings.  In fact, the gap between Pfizer's net earnings and its dividend obligation was only $147 million last quarter.  That's shaving things very thin.  Now, to be fair, Pfizer, whose shares have held up well in a bad year, didn't intend to engineer a near 95% payout ratio. Its typical payout ratio is a far more comfortable 75%.

     But say for the sake of argument that revenue were to fall sharply next quarter.  Instead of earning $2.5 billion, Pfizer earns $1 billion. That's still a tidy profit, but it's half what the company needs to pay the current dividend.  This would put Pfizer -- or any company with a high payout ratio -- in a pickle.  No company wants to reduce, postpone or eliminate its dividend, nor is using its cash savings to pay it very appealing. (Wall Street tends to punish all of those options.) It's the sort of dilemma that will keep the CFO up all night.  

     But the finance chief at Ingersoll Rand?  He may have other concerns, but he doesn't have to sweat the dividend.  It's only $57 million a quarter, and it's typically backstopped by $250 million in net earnings. That's like having your house payment covered by a factor of five -- and still living in a nice neighborhood: Even with such a modest payout, Ingersoll's yield is a full point higher than the S&P average.

     With all of that in mind, a high payout ratio loses some of its appeal.  As a rule, the lower the payout, the more stable the dividend will be.  A modest payout ratio gives the company options that a higher payout ratio may not.

     What's more, investors reward long-term dividend stability, even in a downturn. S&P's "Dividend Aristocrats" -- companies that have hiked dividends for at least 25 years -- have outperformed the market by 12 percentage points this year, on top of generating cash for shareholders. Their average payout ratio is 40.8%, though their average yield is nothing special for serious income investors.