Getting to grips with dividend ratios

Fsp Invest, 01 Nov. 2013

Tags: dividend ratios, financial ratios, dividend yield, dividend pay-out ratio, what is the dividend yield, what is a dividend pay-out ratio,

If you’re looking to invest in a company for its dividend pay-out, then there are a couple of ratios that you need to get to grips with. These ratios will help you weigh up how big the dividend payment is and how much of its money a company pays out. Read on to uncover two key dividend ratios…

Here are two commonly used financial ratios to use for company dividends, Gareth Stokes in Fear, Greed and the Stock Market explains…

The dividend yield (DY)

If you’re considering an income strategy then you’ll want to know the dividend yield. This is the percentage yield you’ll get on the share for the price you pay.

You can calculate the dividend yield by dividing the dividends per share by the price of the share.

Dividend yield = (Dividend per share/share price) x 100

Let’s say XYZ Holdings is trading at 200c a share. It decides to pay a 5c dividend.

The dividend yield of XYZ Holdings is 2.5% ((5c/200c) x 100).

Dividend yields vary greatly from sector to sector. This is due to the differences across various industries.

The dividend pay-out ratio

You can use the dividend pay-out ratio to see how stingy a firm is with its money. It tells you how much of its earnings a company pays out in dividends.

You can calculate the dividend pay-out ratio by dividing the dividends per share by the earnings per share.

Dividend pay-out ratio = (Dividend per share/earnings per share) x 100

Going back to our example of XYZ Holdings, the dividend per share is 5c and earnings per share is 10c.

The dividend pay-out ratio of XYZ Holdings is 50% ((5c/10c) x 100).

It can be hard for a company to strike a balance between dividends and retained earnings.

A favourable dividend pay-out ratio may be great if you’re looking for good income on your investment. But it might not be great if you’re following a growth strategy and hoping for sustained capital growth.

A company might pay this money back to you because they don’t believe they can earn a reasonable return on the cash through current operations.

A company might need to retain earnings to remain competitive and to fund capital expenditure and research and development commitments.

A company that simply pays all of its earnings to shareholders risks becoming uncompetitive.

So there you have it, two key dividend ratios.

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