5 Dividend Ratios To Look At
Before investing in any stocks, you must look at the company’s financial ratios carefully. When we talk about dividend investing, we add a few more ratios to look at. In this article, you will find out about 5 dividend ratios to calculate and to consider before a dividend stocks.
Dividend Ratio #1:
Dividend Yield Ratio
This is a simple dividend ratio to understand but still very important. The dividend yield is the percentage of return you earn from the stock you bought. Therefore, if you invest 1,000 in a stock that has a dividend yield of 3%, you will earn $30 in dividend per year.
How to calculate the dividend yield ratio:
You can usually get this information from any investing websites. However, you can also calculate it. Here’s an example:
Company name: Johnson & Johnson
Company ticker: JNJ (on the American stock market)
Stock price: $59.69
Annual dividend payout: $2.16
Dividend yield (annual dividend payout/stock price) = ($2.16/$59.69) = 3.62%
Dividend Ratio #2:
Dividend 1 year Growth Ratio
The dividend 1 year growth ratio will tell you if the company has recently increased or cut its dividend (you can read more about dividend increase and dividend cut). This is an interesting information as it gives you an idea of the management team perception on the future of the company. If the dividend 1 year growth ratio is positive (let’s say 5%), this means that the company thinks that it will be able to maintain its dividend payoutin the future. On the opposite, a dividend 1 year growth negative would reflect a dividend cut, which leads to potential financial problems over the short term (for example. BP cut its dividend back in 2010 when their pipeline broke and created one of the most important oil leak of the history).
How to calculate the dividend 1 year growth ratio:
You can usually be able to calculate it by taking last year dividend payout and this year dividend payout. For example, if a company paid $1 of dividend per share last year and is now paying $1.10 dividend, your 1 year dividend growth is 10%.
Dividend Ratio #3:
Dividend 5 years Growth Ratio
This is exactly the same idea of the dividend 1 year growth ratio; you want to know where the company’s dividend yield is heading. What is interesting with the 5 year dividend growth ratio is that you can see a clear trend in the dividend payout. If the 5 year growth is similar to the 1 year growth, this means that the company has the habit of systematically increase its dividend year after year.
You can find the best dividend payers (companies that have been increasing the dividend for more than 5 years) among the following list:
Dividend Ratio #4:
Dividend Payout Ratio
The dividend payout ratio (DPR) is very important as it gives you a clear indication of whether or not the company will be able to maintain its dividend payout.
How to calculate the Dividend Payout Ratio:
Here’s the ratio formula:
DPR = Dividends Per Share / Earning Per Share
For example, if a company paid out $1 per share in annual dividends and had $3 in EPS, the DPR would be 33%. ($1 / $3 = 33%). Another way to get the same ratio is to calculate:
Dividends / Net income
In the end, what is important is to understand if 33% DPR is high or low. I personally privilege dividend payout ratio under 75% (and aiming usually for 50% or lower). This means that the company has a lot of room to maintain its dividend in the future.
Dividend Ratio #5:
The logic behind looking at earning growth is to know (again) if the company will be able to maintain its dividend. Earnings are defined as revenues minus costs minus taxes. In other words, earnings are what is left in cash in the company (e.g. whas it left to be distributed as dividend or reinvested). If earnings grow, then your chances of seeing a dividend increase grow as well.
Quick Guidelines concerning Dividend Ratios
If you are looking at a stock and you wonder if the ratios are good or bad, you can follow this simple model:
Dividend yield: must be over 3%
Dividend 1 year growth ratio: must be positive (5% and up is better, but some year, you may have no dividend increase for some reasons).
Dividend 5 years growth ratio: must be over 5% (than you know that you have a consistent increase in your dividend payout)
Dividend Payout Ratio: must be under 75%
Earning Growth: must be positive