Dividends, a topic that I think every new investor will wonder about. Especially they heard the term income securities for first time, at least it happened to me. Enough of the stories, let’s go back to the main idea, WHAT’s there that is related to DIVIDENDS, and HOW can it help us in the portfolio or the screening ?
Dividend Payout Ratio
Also known as Dividend Payout Percentage , this value signifies the percentage / ratio of dividend issued to shareholders from the company’s earnings. For example: 80% payout ratio which means the company pay 80% of its earning to the shareholder in the form of dividends. And the remaining 20% would most likely as investment for expansion, or other financial activities.
Companies that has high payout ratio will most likely companies that is stable, and is financially strong with cash piled up at its own expense, thus able to pay high percentage of earnings back to shareholders. However, this is just a simple observation, for a more thorough analysis, one should look at its historical payout ratio of at least previous 5 years. This simple study of payout ratio in the past 5 years, can reveal how healthy has the company been and its willingness to award its shareholders with high payout ratio.
There would be a drop in the payout ratio, if the company is planning an expansion or just to secure more liquidity to weather the storm during economic crisis. With enough liquidity in cash, companies as such most likely will emerged expanded or grow after the crisis cycle.
Usually, companies with the high dividend payout is companies that’s matured, and less reinvestment on the companies needed for expansion. One way to check, we can always benchmark companies from the same industry and see if this is the trend whether the industry itself is matured or the company is matured with a geographical / regional presence.
Dividend Yield
While payout ratio talks about how much earning has been used to pay shareholder, and thus showing the maturity of the company with extra earnings and doesn’t plan for any expansion any time soon. Dividend Yield is the income ratio per share for the shareholder, thus the term income securities. For companies that pay dividend, its shareholders will be receiving income in the form of dividend, and the yield is translated into percentage to show if its attractive enough or at least “maintain the purchasing power” by beating the inflation rate.
Mathematical Formula:
Dividend Yield = Most Current Full Year Dividend / Current Share Price
In layman’s term, dividend yield is the return of your investment. Assuming, there’s no stock price appreciation, thus we paid the full current stock price and that’s our investment. Dividend yield will then be our return on investment for the stock price that we’ve paid. Historically, companies that has strong financials, they will use dividends to attract stock purchase / shareholders during the economic crisis, and during these turmoils, stock prices will most likely plunged, however stock prices is just a small facet of listed companies, the real strength still lies behind its capability to generate future income and stay in business. Thus, this is most likely a perfect entry time because P/E will mostly be lowered with stock prices dropped, thus the companies appeared cheap and with the dividends, it acts as a safe haven for investors to get returns on the monies invested.
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Being an follower of Value Investing, dividend paying is one of the screening criteria. Personally, I’m looking for companies that are at least a dividend yield around 3.5%. This might seems low to some people, but at the same time, I’m looking for capital appreciation as well, which means there’s reinvestment of the earnings for expansion or R&D for tech-based companies.
There’s certainly more usage of dividends as one of the criteria for stock screening and for analysis on the health of a company. I will be adding from time to time if I encounter any more usage / use cases.