There are 4 Ratios to Evaluate Dividend Stock. Dividend stock ratios are used by investors and analysts to analyze prospective dividends that a firm may pay out. Dividend payouts are determined by a variety of criteria, including a company’s debt burden, cash flow, earnings, strategic plans and the capital required to implement them, dividend payout history, and dividend policy. The dividend payout ratio, dividend coverage ratio, free cash flow to equity, and Net Debt to EBITDA are the four most popular ratios.
Dividends may be paid to shareholders by mature organizations that are no longer in the growth stage. A dividend is a cash distribution of a company’s earnings to its shareholders that is issued by the board of directors of the firm. A corporation may also pay dividends in stock or other assets. Dividend rates are typically expressed in terms of dollars per share, but they can also be expressed as a percentage of the stock’s current market price per share, which is known as the dividend yield.
Dividend Stock Ratios Explained
Some equities offer greater yields, which may appeal to income investors. Under typical market conditions, a stock with a dividend yield greater than the 10-year Treasury yield in the United States is considered a high-yielding stock. The 10-year Treasury yield in the United States was 0.91% as of June 5, 2020.
As a result, any firm with a trailing 12-month dividend yield or projected dividend yield of more than 0.91% was classified as a high-yielding stock. However, before investing in equities with high dividend yields, investors should consider if the payouts are sustainable over time. Dividend-paying company investors should assess dividend quality by examining the dividend payout ratio, dividend coverage ratio, free cash flow to equity (FCFE), and net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio.
Dividend Payout Ratio
The dividend payout ratio is computed by dividing annual dividends per share (DPS) by earnings per share (EPS) or total dividends by net income. The dividend payout ratio denotes the percentage of a company’s annual earnings per share that is paid out in cash dividends per share. Cash dividends per share can alternatively be read as the percentage of net income paid out in cash dividends. A corporation that pays out less than 50% of its earnings in dividends is deemed steady, and the company has the potential to increase its earnings over time. However, a company that pays out more than 50% of its profits may not be able to increase its payouts as much as a company with a lower dividend payout ratio. Furthermore, corporations with high dividend payout ratios may have difficulty maintaining dividends over time. Investors should only compare a company’s dividend payout ratio to the industry average or similar companies when analyzing its dividend payout ratio.
Dividend Coverage Ratio
Divide a company’s yearly EPS by its annual DPS or divide its net income less mandated dividend payments to preferred shareholders by dividends payable to common stockholders to calculate the dividend coverage ratio. The dividend coverage ratio calculates how many dividends a corporation might pay to its common shareholders using its net income over a given fiscal quarter. A larger dividend coverage ratio is generally preferable. While the dividend coverage and payout ratios are reliable criteria for evaluating dividend firms, investors should additionally consider the free cash flow to equity ratio (FCFE).
Free Cash Flow to Equity
After all costs and obligations have been satisfied, the FCFE ratio calculates the amount of cash that is still available to be distributed to shareholders. The FCFE is arrived at by taking the net income, deducting the net capital expenditures, the net debt repayment, and the change in the net working capital, and then adding the net debt. The complete payment of a company’s dividends is something that investors normally desire to see, and FCFE may provide this for them.
Net Debt to EBITDA Ratio
A company’s net debt to EBITDA (earnings before interest, taxes, and depreciation) ratio is determined by dividing its total obligation minus its cash and cash equivalents by its EBITDA. EBITDA stands for earnings before interest, taxes, and depreciation. A company’s leverage and its capacity to satisfy its debt obligations can be measured using the net debt to EBITDA ratio. When compared to the average in its industry or to other businesses that are comparable, an organization that has a ratio that is lower is seen as more desirable. If a dividend-paying company has a high net debt to EBITDA ratio and the ratio has been increasing over numerous periods, this implies that the company may decrease its dividend at some point in the foreseeable future.
Special Considerations for Dividend Ratios
Each ratio offers insightful information regarding a stock’s capacity to maintain its current dividend payments. Investors who are interested in evaluating dividend stocks, on the other hand, should not rely on a single ratio alone because there are other signs that may signal the firm may reduce its dividend payment. When analyzing dividend companies, investors should utilize a variety of ratios, such as those discussed above, to get the most accurate picture possible.
Summery
- The dividend stock ratios of a firm are a useful indicator of the company’s potential to continue paying dividends to its shareholders in the years to come.
- The dividend payout ratio, the dividend coverage ratio, the free cash flow to equity ratio, and the net debt to EBITDA ratio are the four ratios that are used the most frequently.
- It is generally accepted that a low dividend payout ratio is superior to a high dividend payout ratio. This is due to the fact that a high dividend ratio may suggest that a company may have difficulty continuing to pay dividends over the course of the long term.
- When analyzing dividend stocks, investors should look at the equities using a variety of ratios.