Thread by @tradersushma

Ratios to study while selecting stocks for Dividend-Investing.

✨DIVIDEND PAYOUT RATIO
✨DIVIDEND YIELD RATIO

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DIVIDEND PAYOUT RATIO & RETENTION RATIO
The dividend payout ratio (DPR) is the ratio of total amt of dividends paid out to shareholders relative to the net income (earnings after tax & interest) of the company.

It is % of earnings paid to shareholders via dividends.

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Total earnings of a company comprise of 2 parts ~

🔹Dividend payout ratio (the dividend it pays) &
🔹Retention Ratio (the amount it retains for re-investing in the business).
Eg.

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The retention ratio is the proportion of earnings kept back in the business as retained earnings. It is the % of net income that is retained to grow the business, rather than being paid out as dividends. The retention ratio is also called the plowback ratio.

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Formula for calculating DPR :

= Dividends paid / Net Income

OR
= (Number of Equity Shares X Dividend Per Share) / Earnings after deducting the Preference Dividend.

OR
= 1 – Retention Ratio

OR
= Dividend Per Share / Earnings Per Share * 100

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Dividend Per Share is the amount of dividend paid to shareholders. However, it does not include the dividend paid to preference shareholders. We can calculate DPS by dividing total dividends distributed among equity shareholders from the total number of equity shares.

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Earnings Per Share is the net earnings per share after paying off all the expenses and taxes. We can calculate EPS by dividing net income less preference dividend from average number of outstanding equity shares.

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Significance of Dividend Payout Ratio :

⚡️It shows the maturity of the company. Newly established companies may have a low or nil DPR because they are more focused on reinvesting their income to grow the business.

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While an older established cos would like to return value to their shareholders in form of higher payout of dividends. So, these cos shall have higher DPR.

⚡️Dividend pay-outs differ industry to industry. They are useful to compare different cos within a given industry.

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⚡️Long-term trends in the payout ratio matter a lot. A steadily rising ratio could indicate a healthy, maturing business, but a spiking one could mean the dividend is heading into unsustainable territory.

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⚡️It may seem that a company having a higher payout ratio is better option than a company with a lower ratio. However, it is not necessarily true. Consistency or long-term trends are what you should focus on, more than the dividend rate.

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A company with a stable 30% payout ratio for 10 years, is more trustworthy than a company with a payout ratio of 50% but which is consistently on the decline over the years.

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DIVIDEND YIELD RATIO

The dividend yield ratio (DYR) is the ratio that shows how much a company pays out to its shareholders in dividends each year relative to its stock price.

It is the % return on your investment in the form of dividends only.

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Formula to calculate DYR :

Dividend Yield = Dividend per share / Market Price per share * 100

From the above formula it is clear that a stock’s div yield rises if:
1.Dividend increases
2.Stock price decreases

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DYR is an important parameter considered while selecting high dividend paying stocks. Usually, investors are attracted to stocks with high DYR. But it is important to find the reason for exceptionally high DYR of a stock.

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Usually, high DYR results from decreasing stock prices & not div increase. Hence, never pick stocks based solely on its DYR.

Assuming there is no change in dividends, high DYR may result due to falling market price of the stock & vice-versa.

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So, historical data of DYR & its correlation to the stock prices should be studied while selecting stocks for investment.

Stocks should be picked on Total returns criteria & not only on high dividend yield return basis.

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Following are some of the red flags wrt DYR & investors need to be on alert if any of the following thing happens ~

1. If a stock’s div yield is much higher than avg div yield of the stocks in its sector (3% or more)

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2. If a stock’s div yield is much higher than the overall market index div yield (5% or more)
3. If a stock’s div yield is much higher than its long term avg yield (2-3 times its historical yield)

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Summing up,

High dividend yield & low payout ratio is the ideal scenario for dividend stocks. High DYR ensures high ROI while low DPR ensures that chunk of company’s profits is retained for future growth prospects.

That's all for this thread!

If u found this useful, RT the 1st thread for wider audience.

Meanwhile follow @tradersushma more such informative threads on trading, investing & personal finance.

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