Last updated on 18 July, 2023
Our research delves into assessing the dividend-paying potential of a company, both independently and in comparison to other companies within the same sector, and also across the broader S&P500 index. Dividends are the part of a company’s profits that are distributed to shareholders and can be a significant factor in investment decision-making, particularly for income-focused investors. We conduct a detailed analysis of two specific measures that offer key insights into a company’s dividend-paying potential:
Metric D1: Forward Dividend Yield – This metric offers a view on the expected return on investment from dividends over the next 12 months, calculated as a percentage of the company’s current stock price. A higher dividend yield can indicate a higher return from dividends, relative to the stock’s price. However, an excessively high yield can also be a warning sign that the dividend may be at risk of being cut.
Metric D2: Dividend Growth % (Year-over-Year) – This metric measures the percentage change in the company’s dividends per share over the past year. It shows how the company’s dividend payments are evolving over time, indicating its commitment to returning profits to shareholders and its financial health.
These two metrics provide essential insights into a company’s commitment to delivering shareholder returns through dividends and its ability to sustain or grow these payments.
We discuss these two metrics regarding Dividends below, with examples. (The rest of this page is incomplete, as of 18 July, 2023)
Dividends: In the world of business, dividends refer to the monetary or additional shares given by corporations to their shareholders. They represent a part of the company’s earnings and serve as a method for companies to distribute a portion of their profits back to the owners – the shareholders. However, not every company offers dividends. Businesses, particularly in their growth stages, often choose to put all their earnings back into the company to stimulate further expansion. Firms with consistent, substantial profits are more inclined to provide regular dividends.
Dividend Yield: Dividend yield is a significant financial ratio that signifies the proportion of dividends a company distributes each year in relation to its stock price. It’s represented as a percentage and can be computed using the formula: Dividend Yield = (Annual Dividends per Share) / (Price per Share) To illustrate, suppose a company provides an annual dividend of $1.00 per share, and its current share price is $20.00, the dividend yield in this case would be 5% (1/20 = 0.05).
Investors seeking to generate income from their investments find the dividend yield a valuable metric. Higher yields indicate more income generated for the same amount of investment. Nevertheless, an extremely high yield could be a warning sign indicating potential problems with the company. This might be because the company’s stock price has seen a considerable drop, or it might be due to the company distributing more dividends than it can feasibly afford, possibly in an effort to sustain its stock price.
Additional Key Metrics Related to Dividends:
Payout Ratio: This ratio indicates the portion of a company’s net income that is distributed to shareholders in the form of dividends. It’s expressed as a percentage of the company’s net earnings. A high payout ratio may suggest that the company might struggle to maintain its dividend payments in the future.
Dividend Growth Rate: This rate demonstrates the pace at which a company’s dividend payment has increased over a certain duration. It’s a crucial element for investors seeking a gradual increase in their investment income over time.
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of corporate finance. McGraw-Hill Education.
- Damodaran, A. (2012). Investment valuation: Tools and techniques for determining the value of any asset. John Wiley & Sons.
- Ross, S. A., Westerfield, R., & Jordan, B. D. (2015). Fundamentals of Corporate Finance. McGraw-Hill Education.
- Allen, F., & Michaely, R. (2003). Payout policy. In Handbook of the Economics of Finance (Vol. 1, pp. 337-429). Elsevier.