Tuesday, April 24

The Dividend Project - Payout Ratio

Thanks to comments from Frugal Trader and m00m the idea of the payout ratio or percentage dividend payout has been raised. The way I understand it, this is basically the percentage of the earnings that is returned to investors as a dividend.

Why is this number important? I have some ideas:

  • it shows how much of the profit is being invested back into the business
  • a high ratio (on a scale of 0 to 100) shows that most of the profits are leaving the business
  • a high ratio may be unsustainable and could lead to future dividend cuts
  • a low ratio means money is staying in the company
  • the low ratio could show a company philosophy that keeps dividends below what they could be and the investor does not see the immediate share of profits that other companies may offer

There may be other reasons that this number is important. Please feel free to add to the list... :)

Globeinvestor.com provides this number and today's stats show the following for the 5 bank stocks we have been talking about:

BMO 42.55%
BNS 41.44%
CM 34.92%
RY 39.07%
TD 27.77%

Now, I should caution that I wasn't able to get these same numbers. Using the last annual numbers (October 31) for each, this is what I got:

BMO 43.05%
BNS 41.78%
CM 36.80%
RY 39.45%
TD 27.86%

For some reason mine are slightly higher in every case. There must be some variation of the rule that I don't know about.

Anyway, if we use their numbers they should at least be consistent and we can again see an example of most of the sector falling in a fairly narrow range. This time the odd man out is TD, who has a very low payout ratio by comparison. Does this mean that TD may have extra room to increase its dividend? Also, these numbers don't seem to justify BMO's higher yield as was suggested in the comments. BNS and RY are both very close to the same as BMO but they are yielding in the standard range.

I have been working on this series for a while and I know that each post shows only one piece of the puzzle. I am going to try to start pulling things together soon. Here are links to previous posts in this series in reverse chronological order:

5 comments:

Dan said...

BMO's yield is higher because they only increased there payout ratio last May. I don't think the price has caught up to the higher dividend yet.

"Announced a $0.09 or 17% increase in dividends to $0.62 per common share in the third quarter and raised the target dividend payoutrange to 45-55% from 35-45% of net income available to common shareholders"

http://www.globeinvestor.com/servlet/story/CNW.20060524.C0631/GIStory/

mOOm said...

In Aus the tax code favors paying out all Australian sourced profits. Firms then borrow money to invest. The latter has to be part of the picture. Australian firms that earn mainly foreign profits (e.g. Ansell ANN.AX) buy back shares instead or reinvest in the business with less borrowing.

S. B. said...

A few additional thoughts to offer you:

1. The payout ratio is to a large degree based upon what potential incremental projects the company has to invest in. Higher growth companies tend to have lower payout ratios because they have opportunities to deploy the new capital at high rates of return internally. Lower growth companies may find that they have limited opportunities and shareholders may prefer to take the capital in the form of dividends and invest it themselves elsewhere.

2. The payout ratio can be higher than 100. Dividends are a cash expense, while earnings are based on accrual accounting. Thus, the payout ratio can be higher than 100 -- at least for a while. The company could be leveraging itself by borrowing the money for dividends, or could be drawing down cash reserves, or the earnings may only be depressed temporarily due to non-cash expenses. Payouts greater than 100 are not typical, and many times are not desirable -- just pointing out that the ceiling is not 100.

3. I would also very much recommend calculating the sustainable growth rate for companies you invest in. This is defined as return on equity times the retention rate.

the money diva said...

dan,
Thanks for the additional info about BMO! It's strange that the markets have been so inefficient to not catch up yet.

m00m,
Good point. It is important to understand the parameters that drive dividend (and other) decisions.

sb,
Those are all very helpful things to consider although I must admit that I don't understand #3. Perhaps you would like to elaborate or post on your blog about that?

Thanks for all the great input!
MD

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