The Dividend Payout Ratio
As an investor buying stock makes you a partial owner of the company, giving you a “share” of the total pie.
If a company has one million shares and you own 100 of them, you are a 0.01% owner. This is calculated by dividing the number of shares you own by the number of shares that have been issued by the company.
Benefits of Being a Stock Shareholder
Owning stock means you are entitled to these major benefits.
- Capital growth as share prices increase
- Collect an annual dividend payment as partial owner
- Ability to have a say in the management of the business (voting rights)
For the purpose of this article, I will focus on exploring the second benefit, collecting a dividend.
Also I will explain the dividend payout ratio and what it means for you as an investor, and trader.
Basics of Dividends for Investors
Dividend payments are made to shareholders before the date of record. If you own the stock before this date, you are eligible to receive the quarterly, or annual dividend.
The day before the “date of record” is the ex-dividend date, which means as a new stock buyer you will not receive this dividend. That is, you buy the stock excluding the dividend.
So now that you own the stock, you are a shareholder who receives dividend income.
But how do you decide which company pays the best dividend? Is a $1 dividend in two companies the same thing?
Hence, this is where the concept of the dividend payout ratio is very important.
Dividend Payout Ratio
The dividend payout ratio is the amount of dividends paid to share holders versus the the amount of total net income of that company.
Formula for the dividend payout ratio:
Hence you can see that a dividend alone is not a relative comparison across companies. Therefore, knowing what percentage of the net income a company pays you is much more important than the total you are actually receiving.
This brings us to a very important question, which I discuss next.
Is a Higher Dividend Payout Ratio Better?
Unfortunately, like many other questions in finance and investing, there is no definite answer. It depends.
If a company pays out a higher dividend in comparison to its net income it benefits the investor.
But what is the cost?
What if that company could grow every $1 USD of dividend into $5 USD next year?
That is a 500% return.
Would you still want to be paid $1 today or the $5 in one year?
If a company has high growth opportunity, dividend payment stifles the return.
Thus, you want to identify in which stage of life your company of interest operates.
New businesses have tremendous opportunity in growth and need the capital to take advantage.
Mature businesses will have more cash flow as they spend less on innovation, and have higher dividend payout ratio.
As a result, you need to make sure you compare apples to apples as an investor. Don’t just get sucked into a decision on the outcome of just the dividend payout ratio.
Where to Find Dividend Payout Ratios?
Click here to visit Yahoo Finance screener to see free fundamental ratios, including the dividend payout ratio.
If you want to find out the best stock screeners click here.
From here, you can start your journey into statement analysis and comparing companies you plan to invest it.
Click here to learn how to decide if the stock market is overvalued using fundamental analysis.
Dividend Payout Ratios – Conclusion
Every ratio is just one extra tool in the investors belt.
But do you need to know the answer to trade successfully?
In fact, fundamental analysis is often irrelevant to a trader who looks to just profit form a price movement in the short term.
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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.