Make Sure You’re Checking These Dividend Stock Ratios
It’s important to know what a company is likely to pay out later on. Dividend stock ratios help investors and analysts assess how much a company can pay in dividends in the future. Multiple factors influence such payouts including a company’s earnings, debt load, and cash flow.
Companies who have matured over time may opt to pay dividends to shareholders in the form of:
- Cash distribution of the earnings of the company as declared by its board of directors
- Dividends in the form of stock or assets
Dividend rates are typically quoted as dollars per share or as a percentage of the stock’s present market price/share (dividend yield). Stocks with higher dividend yield are obviously more attractive to investors but before getting too excited, it’s important to check if this performance of the stock can be maintained the long run. Dividend stock ratios are crucial for this analysis.
The most popular dividend stock ratios you should be checking are:
Dividend payout ratio
This is calculated by dividing annual dividends per share (DPS) by earnings per share (EPS) or the total dividends by net income. This is representative of the amount of the company’s annual earnings/share paid as cash dividends per share.
Any company that is paying out less than 50% of its earnings as dividends is a stable company. A company paying out more than this percentage may struggle to maintain dividends in the long run or find it more difficult to increase dividends than companies with a lower dividend payout ratio. It’s necessary to assess this based on the ratio in similar companies or by considering the industry average.
Dividend coverage ratio
This ratio gives an understanding of how many times a company will be able to pay its common shareholders dividends with its net income for a particular fiscal period. The higher the ratio, the better it is for shareholders. This ratio is calculated as company’s annual EPS divided by its annual DPS.
Free cash flow to equity
This will give investors an idea about whether a company’s dividend payments will be made fully. This gives a picture of the cash that can be paid to shareholders after accounting for the payment of debts and expenses. From net income, the following are subtracted:
- Net capital expenditure
- Change in net working capital
- Debt repayment
To this, net debt is added to get an idea of free cash flow to equity.
Net Debt to EBITDA (earnings before interest taxes depreciation and amortization)
Here, a company’s total liability less its cash and cash equivalents are divided by its earnings before interest taxes depreciation and amortization. This gives an idea of whether or not the company will be able to meet its debt. A lower ratio set against similar companies or the industry average is desirable. If this ratio is high, a company may look to make dividend cuts in the future.