Table of contents:
- Foreword
- What are dividend shares anyway?
- Dividend yield
- Payout ratio
- Dividend growth
- Dividend increases
- Profit/cash flow growth
- Brief explanation: Ex-day
- Conclusion
I. Foreword:
The following article is about the key figures that are used to evaluate dividend stocks. To do this, we will look at some key figures and clarify what key figures such as the payout ratio actually are, what benefits they can have for us and how they are calculated. I will use a good and a bad example to illustrate each point. If you want to find out more, for example about the valuation (i.e. the fair value), you should definitely visit @TheAccountant89 in any case.
As this article is mainly aimed at beginners, the more experienced will probably find most of it familiar. Well, let's get started.
II. What are dividend shares anyway?
Every year, companies distribute a portion of their profits to everyone who holds shares in the respective company, the so-called shareholders. These companies are usually slow-growing, stable companies that have been making profits for a long time. The dividend is basically a payment to shareholders for putting their money up for investment.
Companies that pay a dividend are popular with many shareholders, as they represent a relatively secure additional income and can be good for the psyche to receive a small payment from time to time during market phases such as the current one.
However, it is important to note that when a dividend is paid, this money leaves the company and ends up with the shareholder. I will go into this in more detail later.
III Dividend yield
The dividend yield is the ratio of the dividend paid out in a year to the current price of a share and is always expressed as a percentage. This is briefly explained using the Apple share as an example:
At the current time, an Apple share costs €161.30. In 2021, the dividend per share was €0.85.
General calculation: (Dividend per share/the current share price - 100)
Example Apple: (0.85/161.30) - 100 ≈ 0.53%
Apple's dividend yield is therefore currently approx. 0.53%
IMPORTANTThe dividend yield always refers only to the dividend for the previous year, unless a company has already published every single dividend for the current year. However, if you look at various financial websites, they usually calculate with the past dividend
‼️ The dividend yield alone is no indication of the quality of a company. Very high dividend yields are often a warning sign that something is wrong. The share price has only been going down for a long time, the company is trying to entice investors with the high dividend yield, but has nothing else to show... Please note ‼️
IV. Distribution ratio
The payout ratio is the percentage of profit or free cash flow that is then distributed to shareholders. A ratio of 25-75% is generally considered healthy. Companies with a payout ratio of 100% or more should be avoided, as these companies pay out more than their cash reserves or profits can cover. Ergo, the companies take on debt in order to be able to pay out the dividend, which is definitely not healthy.
As already mentioned, there are two payout ratios: one based on profit and one based on free cash flow. Using FCF makes more sense than calculating using profit, as FCF is the money that is freely available and profit still has to take into account depreciation, amortization and provisions.
The calculation requires the cash flow per share (or earnings per share) and the dividend per share:
Generally, (dividend per share/cash flow per share) - 100
Example Procter&Gamble: P&G paid a dividend of $3.52 per share in 2021 and had a cash flow of $6.59 per share. This results in the following payout ratio:
(3,52/6,59) - 100 ≈ 53% ✅
Now let's take a look at a negative example: Armour Residential REIT paid a dividend of $1.20 per share in 2021. Since the company doesn't even have cash flow, let's use earnings, which amounted to $0.05 per share in 2021.
( 1,20/0,05) - 100 ≈ 2400% ‼️
The payout ratio in relation to earnings is an incredible 2400%. Armour Residential is therefore distributing 24 times the amount of money that is actually available. A first warning signal. The company also has a dividend yield of around 10%, a second warning signal. A low AQ, on the other hand, can provide information about the growth of a company. If the dividend is steadily increased but the AQ remains roughly the same, you can conclude that the company is healthy and growing and will most likely continue to increase its dividend in the future. However, I will come back to dividend growth in a moment.
V. Dividend growth
Dividend growth describes the change in the amount of the dividend between two payments and is also expressed as a percentage. Stable companies increase their dividend by a certain percentage every year. Companies with high dividend growth usually have a low dividend yield and medium to high growth (e.g. ASML, Broadcom)
Companies with low dividend growth are usually established companies with a relatively high dividend yield (e.g. 3M, P&G). Of course, there are exceptions. Walmart, for example, has neither a particularly high dividend yield nor high dividend growth, unlike asset manager T. Rowe Price, for example.
Let's take a look at these two companies:
T. Rowe Price has increased its dividend by around 11.5% per year from 2018 to 2021. If growth remains constant, this will result in a dividend yield of around 10% in 10 years (2031) (currently around 4%). This shows that buy&hold and compound interest can lead to incredible dividend yields in the long term (assuming growth rates and the share price remain the same)
If you look at Walmart, whose dividend grew by approx. 1.5% per year between 2018 and 2021, this results in a dividend yield of approx. 3% in 10 years (currently approx. 1.7%) Not dramatically bad, but not particularly impressive either. It can therefore be said that dividend growth is at least as, if not more, important than the dividend yield.
VI Dividend increases
The dividend increase indicates how many consecutive years a company has increased its dividend. Different companies can also be assigned to different groups:
The most important two are the dividend aristocrats and the dividend kings. There are conditions for being accepted into the club of one of the two.
Dividend King: Dividend has been increased for 50+ years ( examples: Coca-Cola, 3M, Procter&Gamble).
Dividend aristocrats: Dividend has been raised for 25+ years, daily trading volume is $5 million, market capitalization must be $3+ billion ( examples: T. Rowe Price, Cardinal Health, Caterpillar)
A long dividend history can also help to assess the stability of a company. If the dividend has been steadily increased over many years (even during crises such as wars and financial collapses), this is evidence of a successful company that has repeatedly demonstrated its strength in the past.
IMPORTANT: As there is often a lot associated with this share (prestige, place in indices), it can also happen that the company goes into debt in order to be able to continue paying the dividend. This is relatively rare, but should be taken into account.
VII Profit/cash flow growth
Good companies are known to manage to increase their profit and cash flow every year. A growth rate of 3-10% is considered healthy. Currently omnipresent, the average inflation rate, which was 2.6% per year from 1960-2021, must also be taken into account when examining company key figures. Companies that grow 2% per year on paper actually have negative growth in real terms and should therefore be avoided, as you cannot expect healthy dividend growth. The situation is of course different for companies with relatively high cash flow/profit growth. If these grow consistently at a good rate, it can also be assumed that the dividend paid (if one has been paid and already increased) will continue to be raised.
VIII Brief explanation of the ex-dividend day
On this day, the share price is reduced by the amount of the dividend, also known as the dividend discount. Among other things, this is to prevent people from buying shares just for the dividend and then selling them again.
Share X costs €100 per share before this day, for example. The dividend per share previously approved at the Annual General Meeting is €2. As this €2 per share is taken out of the company and into the pockets of the shareholders, the value of the company is also reduced.
The dividend is therefore simply deducted on the ex-day: €100-2 = €98 per share remains.
So it all boils down to a +/- deal.
But don't despair, dear investors. If you own a good company, the share price will continue to rise. So if there is this discount, you can simply regard it as an everyday fluctuation.
IX. Conclusion
Dividend shares are a great thing. They serve as additional passive income, can multiply the capital invested if you hold the shares patiently and help us shareholders to survive difficult times. It is also very important to ensure that the key figures presented are always viewed in a wider context if you want a reliable result. A high dividend yield can be tempting, but when combined with the payout ratio or dividend growth, the picture is completely different. Always keep this in mind. In this article, I have only focused on key figures that are directly related to the dividend. However, if you agree, I would be happy to turn this into a series and devote further "chapters" to growth shares or other key figures (such as the equity ratio). It's up to you.
I very much hope that I have been able to help you, especially the beginners among you, and that you now understand the stock market a little better. If I was able to help just one person, the effort was already worth it 🥴
To be continued...maybe...
Sources:
- https://www.captrader.com/ex-dividende-und-ex-tag/
- https://harkort.consulting/blog/gesundes-wachsen
- https://finment.com/boerse-aktien/dividenden-aktien/dividenden-aktien/
- https://wir-lieben-aktien.de/aktien-und-boersen-lexikon-definitionen/dividendenwachstum/
- https://sumup.de/rechnungen/lexikon/cashflow/
- https://www.value-akademie.com/dividendenaktien-finden-und-richtig-bewerten/
