Overview
Shareholders and investors use fundamental analysis to analyze the performance of a company. Dividend Yield and Payout are two important metrics in the fundamental analysis. Often, both of these measures are considered in conjunction along with other key financial ratios.
Dividend yield and payout are both related to the dividend paid to shareholders. However, both present a different scenario for shareholders, investors, and the company itself. Yield concerns the shareholders looking for regular income through dividends. Whereas payout ratio concerns investors and the company about how much of the profits can and should be distributed to the shareholders.
Let us understand both concepts and analyze how both of these terms present key information about the dividend strategy of a company.
What is Dividend Yield?
The dividend yield is a ratio that describes how much a company pays in dividends on each share compared to its market price. The ratio is expressed in percentage terms and denotes the dividend per share divided by its market share price.
Dividend yield expresses a direct link between the dividend amount and the market share price. Thus, a movement in either of these metrics can affect the yield. For instance, if a company keeps the dividend ratio the same but its market price increases, it will decrease the yield.
How to Calculate Dividend Yield?
Dividend yield can be calculated as a percentage term.
Dividend Yield = (Dividend Per Share/Price Per Share) × 100
For example, a company has a current share price of $40 and pays a dividend of $ 1.5 per share.
Dividend Yield = (1.5/40) ×100 = 3.75%
If the dividend per share is not available, we can take the latest quarter dividend and multiply it by four to get an annual figure.
Understanding Dividend Yield
Dividend yield provides the return-on-investment ratio for the shareholders. Shareholders can make profits through dividends or price appreciation in the share price. Dividend yield connects both in a way that expresses a relation of dividend paid in terms of the market price of the share.
Naturally, a higher dividend yield would mean higher returns for the shareholders. However, a higher yield is not always beneficial for shareholders and the company. For example, a company may announce a lower dividend amount from net profits due to a decline in sales for a seasonal or macroeconomic reason. It will lower the yield ratio but does not state a fall in the company performance as such.
Growing companies do not pay dividends regularly. They reinvest profits for steady growth. A lower yield with these companies doesn’t mean bad performance either.
Pros and Cons of Using Dividend Yield
Using dividend yield for the performance assessment of a share has its pros and cons.
Pros Explained
It is a good performance measure for stable companies and a long history. A consistent yield also denotes the company’s strong financial performance. Thus, shareholders can use it for historical analysis and forecast dividend yield.
For the company, it presents an opportunity to gain a competitive advantage. A company paying out consistent yield would gain share price appreciation. Top management can also use the yield ratio in key decisions such as future dividends, retained earnings, and cash flow management.
Cons Explained
Some sectors have to pay higher dividends, for example, companies in the real estate sector and the REITs. Thus, shareholders cannot compare the yield on these shares in absolute terms. Similarly, the tech industry and other rapidly growing companies wouldn’t pay dividends. A zero yield doesn’t mean a share would perform badly.
What is Dividend Payout?
Dividend payout or simply payout is a ratio that expresses the profits distributed to the shareholders in the form of dividends. It is also expressed in percentage terms and denotes earnings distributed as dividends.
A company can utilize its profits for reinvestment in projects or dividend distribution. A payout ratio tells us the proportion of profits retained against distributed in the form of dividends.
How to Calculate Dividend Payout?
The payout ratio can be calculated in percentage terms as:
Dividend Payout Ratio = (Total Dividend/Total Income) × 100 Or
Dividend Payout Ratio = (Dividend Per Share/EPS) × 100
Understanding Dividend Payout
A dividend payout ratio must be seen in conjunction with other key ratios such as retention and dividend yields. The payout ratio alone doesn’t always depict the full picture of a share’s performance.
A company paying too high dividends means it doesn’t reinvest in profit-generating projects. Similarly, a too low ratio would mean the company didn’t generate sufficient profits.
Some analysts use the cash figure instead of the profits to calculate the payout ratio. It provides a clearer picture as dividends are paid from the available cash.
Pros and Cons of Using Dividend Payout
Using a payout ratio for performance analysis cannot provide complete information. However, the payout ratio has several pros and cons for investors when analyzing a company’s performance.
Pros Explained
- It provides a useful measure for investors looking for consistent income through dividends.
- Investors can compare it for historical performance analysis of a company.
- It offers insights on the dividend program followed by a company.
Cons Explained
- It does not offer complete information on a company’s performance in absolute terms.
- There is no ideal payout ratio as it depends on several factors including the company’s industry, growth stage, macroeconomic factors, and so on.
- Top management can manipulate accounting figures to showcase a favorable payout ratio.
Key Differences Between Dividend Yield and Dividend Payout
Dividend yield and payout ratio both relate to the dividend policy of a company. However, both of these ratios provide different information for investors and creditors and the company itself.
Let us analyze some key differences between the dividend yield and payout ratio.
- Dividend yield compares the dividend per share with its market price per share. Whereas payout ratio denotes the percentage of profits doled out in dividends to the shareholders.
- The payout ratio informs us of the profit amount distributed and retained by the company. Dividend yield expresses the return an investor would receive as compared to the company’s share price.
- Dividend yield can never be negative and ranges between 0% to 100%. The Payout ratio can be negative if the company incurs negative profits (losses). The payout can also be more than 100% of the current year’s profits theoretically.
- A higher yield percentage cannot always express a positive performance sign. It can be due to lower market share price or higher dividend ratio. Whereas a higher payout ratio generally is considered favorable by investors.
- As we can see from the formulas above, a payout ratio depends on the company’s profits. Dividend yield depends on the market share price.
- The dividend yield is of prime interest to investors, whereas, the payout ratio is more concerning for the top management decision regarding dividends.
Final Thoughts
Both ratios provide useful information on company performance analysis for investors and the top management. The top management makes a dividend decision. However, both of these ratios depend on two other key metrics as well. Dividend yield directly links with the market share price, and the payout correlates with the company’s earnings.
Stakeholders and analysts should use benchmarking standards to evaluate both of these ratios. It is wise to look at the broader picture and determine the key drivers behind the change in these ratios.
