There is an investing adage that basically states high yield = high risk. All investors understand this wisdom. But what if you find a high yield stock, and the company has a low PE ratio and a low liabilities to equity ratio? Is the company still a good investment?
One additional measure of a company’s ability to pay its dividends is the Dividend Payout Ratio (DPR). This ratio indicates how much of a company’s revenue goes into paying out its dividend to shareholders. For example a company with a Dividend Payout Ratio of 60%, would pay out 60% of its earnings to shareholders, while retaining 40% of that income.
Dividend Investors focus on the DPR, because it indicates a company’s ability to continue paying dividends, and the likelihood that a company will be able to increase its dividend in the future. Obviously a company with a lower DPR will be able to raise its dividend. The DPR can also help to determine (1) if a company is paying all of its earnings as dividends, (2) leveraging or depleting cash to continue paying its dividends, or (3) leaving extra cash flow for future expansion and operating expense. Investors also focus on the DPR, because a company with a DPR over 100% may not be able to continue to pay its dividends, or may cut the dividend.
Dividend investors like to purchase stocks with a DPR of
60% to 70% 30% to 60% as there is also room in the company for future growth, and possible dividend increases. Big utilities on the other hand often have a higher DPR, because they have no room for future growth. So they payout their cash flow as dividends, and thus have slightly higher dividend yields. The concern is a company which has a high DPR over 100%, must either borrow or deplete cash, to make the difference or cut its dividend to remain competitive.
Recently My Own Advisor discussed the DPR for TransAlta Corp. with a current Dividend Payout Ratio of over 107%. He actually phoned their investor relations department, and asked them flat-out if the dividend was sustainable, or whether they were planning to cut the dividend.
How to Calculate the Dividend Payout Ratio
The DPR is very easy to calculate and you should take it into consideration with the rest of your research. The key figures you need are EPS (earnings per share) and the dollar amount of the Annual Dividend. This information is easily obtainable from the Globe and Mail and many other financial sites.
Dividend Payout Ratio = (Annual Dividend / EPS) * 100
For example, Rogers Communications (RCI.B) has an annual dividend of 1.42 / EPS of 2.64. Therefore the DPR = 53.7% which is excellent.
Rogers Sugar, a higher yield stock, is 0.34 / 0.63 = 53.9%. This is also an excellent DPR ratio.
On the other hand Yellow Media (YLO) is 0.65 / 0.54 = 120.3%. This is not a good Dividend Payout Ratio, since Yellow Media must leverage an extra .20 cents for every 1.00 in dividends they distribute.
The Financial Blogger provides monthly updated Dividend Yield and Dividend Payout Ratios for the TSX 60 companies, including the Top 10,Top 20 and Top 50. A good resource, with DPR already calculated!
Companies with low DPR and High Yield
Here is a list of my Top 10 Canadian high income and low DPR stocks. My criteria was based on two fundamentals (1) find dividend stocks with a dividend yield over 4%, and (2) a Dividend Payout Ratio (DPR) below 75:
|Company||Symbol||Price||Dividend Yield||Payout Ratio (DPR)|
|Coast Wholesale Applicance||CWA||4.73||8.9||68.8|
|Sun Life Financial Inc.||SLF||31.09||4.6||51.6|
|Bank of Montreal||BMO||62.42||4.5||58.7|
For the record, I am long on Rogers Communications (RCI.B)