It doesn’t matter if you are a new investor or a seasoned professional. It is very important to know what factors to consider when creating a new portfolio or rebalancing an existing one. After all, market conditions can threaten potential returns. But what metrics should you consider when making those all-important decisions?
Investors use many different indices and metrics when weighing which companies to add to their portfolios. Among them is the Dividend Payment Index (DPR), which looks at dividends paid in relation to a company’s total net income. Read on to learn more about this metric, what it means, and how it can be interpreted.
- The dividend payment ratio is a comparison of the total dollars paid to shareholders relative to net income.
- This ratio is an important aspect of fundamental analysis that can be calculated using data that is easily found in a company’s financial statements.
- DPR is commonly calculated per share by dividing annual dividends per common share by earnings per share.
What is a dividend payment ratio?
The dividend payment rate is a comparison of the total dollars paid to shareholders relative to a company’s net income. It is the percentage of a company’s profits that is used to reward its investors. The dividend payment rate is an important aspect of fundamental analysis that can be calculated using data that is easily found in a company’s financial statements. This ratio indicates what percentage of net income a company spends on paying cash dividends to shareholders.
It is also considered the net income that a company does not reinvest in the business, does not use to pay debts or add to its cash reserves. As such, the payout rate is the opposite of the withholding rate, which shows how much profit the company retains to reinvest in its operations.
Corporate dividend payments and withholding rate
How to calculate the dividend payment ratio
The dividend payment rate can be calculated absolutely by dividing the total annual dividend payment amount by the net income. But more commonly it is calculated per share. This is the formula:
DPR = annual dividends per common share ÷ earnings per share
The payout rate can be determined using the total shareholders’ common equity figure shown on a company’s balance sheet. Divide this total by the current share price of the company to get the number of shares outstanding. Next, calculate the dividends per share by dividing the amount of the dividend payment shown on the balance sheet by the number of shares outstanding.
The earnings per share (EPS) figure can be found at the bottom of the company’s income statement.
Interpretation of the dividend payment rate
The dividend payment ratio is a key profitability index that measures the return on investment. By revealing what percentage of net income a company pays or retains, it can also serve as a metric for measuring a company’s future prospects.
The dividend payment rate can serve as a metric to measure the future prospects of a business.
Active investors don’t always value a high dividend payment rate. An unusually high dividend payment rate may indicate that a company is trying to hide a bad business situation from investors by offering outrageous dividends, or that it simply does not plan to aggressively use working capital to expand.
Analysts prefer to see a healthy balance between dividend payments and retained earnings. They also like to see consistent dividend payment rates from year to year that indicate that a company is not going through boom-bust cycles. Stock traders, unlike buy-and-hold investors, tend to discount stock dividends as they don’t intend to hold their investments long enough to get them.
In recent years, companies at the peak of a business boom have paid little or no dividend to their investors. During the tech boom of the late 1990s, it was even seen as a sign that a company was maturing into comfortable but unspectacular growth.
Considerations for DPRs
One of the factors to consider when it comes to DPR is the maturity of a business. Startups can pay little or no DPR. This may mean that a company is still fairly new and concentrating on growth: research and development (R&D), new product lines, or expansion into new markets. A company that is more established can disappoint investors if it does not pay dividends at all, especially if it has well past its stages of expansion and growth.
DPR and dividend sustainability
Dividend payment rates can also help determine how a business can maintain its dividends. The general range for a healthy DPR is between 35% and 55%. This means that the company is returning approximately half of its profits to shareholders and is reinvesting the remaining half to grow. This type of payout ratio indicates a more sustainable dividend.
A company whose DPR exceeds 100% tends to be unsustainable. It means that you are giving back to your shareholders more money than you are making. The company may have to reduce the dividend or, worse, stop paying it. But this scenario is not very likely, as many companies feel that cutting their dividends can cause a drop in share prices. It can also lead investors to lose faith in the management teams of dividend-paying companies.
The bottom line
The dividend payment rate remains a key factor in stock selection, especially in the long term. Professional portfolio managers generally recommend that an investor dedicate a portion of their portfolio to such income-generating stocks. The recommended portion devoted to such stocks generally increases as the investor approaches retirement.