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I'm trying to up my knowledge in dividends and sometimes I will see a company that has a payout ratio greater than 100% and I think that typically speaking somebody would see that and consider it to be unsustainable. But if it is unsustainable, why would a company make the decision to do it? Would that not go against the company's objectives of profit maximization? In particular, I am looking at Enbridge ( https://seekingalpha.com/symbol/ENB ) as a case study...

Enbridge has done quite well over the past 5 or so years and is one of the largest companies in Canada, but their payout ratio seems to be unsustainable at face value. To me, this indicates that Enbridge is paying out more in dividends to it's shareholders than what it is earning, yet Enbridge has experienced steady Gross Profit growth and still making a decision to pay out at an unsustainable rate.

I am hoping somebody might be able to address this in an educational way. I'm not looking to sink a ton of money into Enbridge, I am just using them as a case study to understand why a company might choose to have an unsustainable payout ratio.

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Taking a quick look at their financials, Enbridge seems to have a lot of non-cash expenses (e.g. depreciation) that reduce their net income to relatively low levels relative to their operating cash flow. So there dividend payout (as a percentage of their net income) is relatively high, but with a stable cash flow and (possibly) limited opportunities for investment, it may be sustainable (it's currently about half of their operating cash flow).

Think of it this way. Companies can do three things with positive cash flow: save it, spend it, or give it back to shareholders (through wither dividends or stock buybacks). For a stable company, saving it may not make sense, and there may not be many opportunities to spend it (i.re. grow their company), so their only other choices are to pay off debt or to give it back to shareholders. Many investors love dividends, so giving it back may be seen as a better use than just paying off cheap (in today's market) debt.

I would also note that many similar companies (gas/oil pipelines) also pay relatively high dividends due to their corporate structure as a Master Limited Partnetship (MLP). While Enbridge is not an MLP, it may feel pressure to keep its dividend high to compete for investors with other similar companies.

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  • If a lot of their expenses are depreciation but they aren't buying new equipment or reserving cash to do it later, won't they eventually find themselves with expired equipment they can't replace? Mar 24 '20 at 21:47
  • @GS-ApologisetoMonica Probably, but Enbridge still has plenty of CapEx as well, so they are still investing somewhat. They may just be at the "cash cow" point where they can feed cash from a stable business to investors rather then trying to grow for the future as fast as possible.
    – D Stanley
    Mar 25 '20 at 12:53
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    @GS-ApologisetoMonica: Yes, a company may find itself in that position. But for a company in a shrinking market, that may be a viable strategy. Say you own a coal mine today, would you still replace your equipment? Profitably shutting down a company is an oft-overlooked business skill.
    – MSalters
    Mar 26 '20 at 10:57
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The dividend payout ratio (in a given year) is also a backward looking metric. It can seem inflated when a company's earnings (read: net income, to EPS) were lower in the previous year, and their expected earnings for the following year(s) are significantly higher.

Additionally, the dividend payout ratio calculates the payout based on net income and cash flow does not equal net income, so the actual FCF available to the company to pay dividends may be much higher. On their CFS you can see their cash flow from operations compared to net income as well. So while the dividend payout ratio can be > 100%, it still is a backward-looking metric and as you mentioned, it likely isn't sustainable but that doesn't mean they have to cut their dividend; they could have high projected earnings for the coming years.

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