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The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
By Carla Pasternak
NEW YORK (
StreetAuthority) -- You've likely relied on this measure of dividend safety countless times: the earnings payout ratio.
The ratio shows the portion of earnings paid out in dividends. If a company earns $1 per share during the year and pays out 50 cents per share, the payout ratio is 50%. This is considered a sustainable payout ratio because it leaves a cushion if earnings fall, and room to grow the dividend if earnings rise.
This ratio is deceptively simple. If you look deeper, you'll see some cracks.
Dividends are paid in cash. But earnings are not cash. Earnings are an accounting device. They are the net income that results from matching revenue with expenses in the same period. The actual cash that's received or paid may come later.
AT&T(T - Get Report) reported $94 billion in revenue for the first nine months of 2011. But $13 billion of that consisted of accounts receivable, meaning services were rendered during the period but no cash payment was received for them. Still, a portion of those accounts receivable ultimately made its way to earnings.
Earnings can be a useful proxy for cash and the earnings payout ratio is a handy tool for many companies. But the difference between earnings (or net income) and the actual cash that pays your dividend is especially great for most high-yield companies. And that limits the usefulness of the earnings payout ratio.
In AT&T's latest earnings statement, for example, depreciation expenses chopped $14 billion from the last nine months of earnings. But depreciation is a non-cash expense. It simply shows that AT&T's fixed assets -- its wireless and landline networks and equipment -- are losing value from wear and tear, aging, or technology changes.
AT&T is not alone. Most high-yield stocks can pay out big dividends because they generate huge amounts of cash flow year after year from fixed assets -- pipelines, shopping centers, oil tankers. These assets lose value as they age, so they generate a lot of depreciation expense. This expense cuts into earnings but doesn't affect the safety of your dividends.