The dividend payout ratio is an important number to check ( along with debt and other things) before you decide to buy a stock for it’s the dividend. Most income investors invest in stocks for dividend and they should check the dividend payout ratio. You can go to Finance.yahoo.com. Search for any stock of your choice. go to Statistics >
The images above are for Coke. As you see it has a pay out ratio of 77%.
So, Is Dividend Payout Ratio High Is Good or Low is Good? It depends, a matured company that is not growing as much will have a higher payout ratio. But, a company that is growing, will have a low payout ratio. And any company that has a high return on equity, you want that company to keep the money instead of paying dividends and compound that money to grow your capital.
So, How to Calculate Dividend Payout Ratio? It is easy. Dividend Payout ratio = Total Dividend Paid out / (Net Income +( Non Cash expenses – non Cash Sales)
Is It Better to Have a Higher Dividend payout Ratio?
For matured companies, which need little capex or capital expenditure to grow business, mostly because the growth of business rate is dropping, may have a high payout ratio. And that might be a good thing for investors to receive the cash. The investor can deploy the cash else where and grow it faster.
You can buy stuff you want with the dividend you get or simply buy more stocks or bonds. IF the company is not growing, that means there is a little chance of PE expansion, so little chance of stock price increase. In that case you should take the cash you receive as dividend and invest that in high growth companies for better return on capital.
Why Allow Dividends In Debt-Ridden Companies?
In a publicly held company, the stakeholders decide if they want to pay out dividends to the investors instead of paying down debts. There are many reasons why they choose to do that. The cost of debt is often low. Mainly because the interest is so low now, companies can borrow for very little cost. And the effective cost of debt goes down because the interest paid on debt gets deducted for earning, which reduces the tax burden on the company.
Income investors love stocks that pay dividends. That is why in 2007 – 2008 GM was borrowing money to pay out dividends, which was an awful decision. But, dividends are a great passive income source. Many retirees actually depend on dividends for income.
In my opinion, I do not prefer companies with too much debt. Usually, debt kills companies. As we witnessed during the coronavirus crisis, the companies that took debt to buyback shares were the first ones to ask for a bailout. So, evidently the debt-ridden companies are not reliable businesses at all.
Is It Good If The Payout Ratio Goes Up?
Many income investors would like to see to payout ratio going up. That will mean the business chose to retain less and distribute more money among shareholders.
If this is a growing company, then a growing dividend payout ratio might disappoint the growth investors. Because this might signal that company is not being able to reinvest all the cash in the business. Or the growth is simply slowing down. Either way, this might be a prudent decision to pay out more cash to investors instead of retaining the cash.