Dividends are like an allowance for the rich.
They make money while you sleep! Who wouldn't love such a luxury?
Here's how they work. Companies release a portion of their earnings to those who have faith in their future. This intelligent group is best known as the shareholders. Believe it or not, there's much to learn about these dividend payouts.
Of significant importance, there's the dividend payout ratio formula.
What is the dividend payout ratio?
Commonly referred to as just a payout ratio, it's the metric that tells us the portion of net earnings being paid to the shareholders (as a percentage). In simpler terms, it's how much they'll pay us versus how much they take home. That's the relationship.
But there's more than meets the eye when it comes to the dividend payout ratio formula.
When you notice a high payout percentage, it signals that the company is willing to share a lot of its earnings, which could come at the expense of company growth. Think about it. If they're paying the shareholders most of the money, how can they grow the business?
On the flip side, if you see a company with a low payout ratio, it can be taken as a token of growth. This is because they don't want to pay the shareholders as much so that they can reinvest back into the company to grow the share price.
It's essential to understand what we're looking at before making an investment decision. An excellent place to start is by asking yourself which you'd like more, growth of the dividend or growth of the share price?
The dividend payout ratio formula
You've already learned what the dividend payout ratio is and where it comes from. But that still leaves us questioning ourselves.
How the heck is the payout ratio calculated?
It's not too complicated, so don't worry about complex mathematics. The formula to find the percentage is this:
Payout Ratio = Dividend paid/Net income
To give you an example, we'll take a quick look at Apple. In 2021, they paid $14.467B in dividends and had a net income of $94.68B.
Doing the math using the formula above, we can see that the payout ratio is 15.3% for the year. This is something that can be calculated for multiple time frames, including quarterly, annually, and even over TTM (trailing twelve months).
Now you'll be able to compare the payout ratio from one company to another potential investment candidate! That's an important step on your journey to dissecting dividend investments. What's more, is that the calculation can be done for you with a spreadsheet extension like Wisesheet.io!
Calculating the dividend payout ratio in Google Sheets or Excel
Let's face it. Doing the dividend payout ratio formula manually would get seriously old after about two times. It's not practical.
As you can see, Wisesheets will let you automatically access this data with the add-on using the WISE function. It's a total time saver. In just one view, you can get the annual, quarterly, and TTM payout ratios for your favorite stocks.
What's more, as your favorite companies release their financial statements, you can get the latest data by entering "ly" or "lq" into the WISE function.
The real impact starts to set in when you utilize the stock lists, showing hundreds of key metrics like ROIC, PE ratios, and payout ratios. In addition, it increases the efficiency at which you can spot (and jump on) market opportunities to boost the performance of your portfolio.
At the end of the day, tracking is a must.
Think about it! If you don't know where your money is going, how it's coming back, and IF it's coming back, how will you reach your goals? How will you build up that emergency fund? How will you save for the down payment on that dream house you've always imagined?
The answer is simple. You most likely won't be able to.
But if you spend just a little bit of time planning and tracking your investment decisions, you can easily dominate the charts and consistently cross off your accomplishments.
Why is this important?
As investors, we need this information to make critical financial decisions.
The dividend payout ratio could impact our selection process if we want to invest in certain companies to achieve specific goals. For example, if we're trying to build up a cash reserve, it might be nice to find a company with a solid history of significant, consistent dividends.
There are even long-term strategies like dividend growth, where investors look for companies with a history of consistently raising dividends year after year. I'm sure you can see how compounding turns into a double-edged sword with this strategy.
Those companies that raise dividends in this manner are called "dividend aristocrats" and "dividend kings." The only difference is how long they've raised payouts. Aristocrats have increased them for at least 25 years, and kings are 50+. Quite astonishing.
The dividend payout ratio can also tell us a lot about sustainability. Whether the company is healthy or not. When you see a giant corporation as a dividend king, it's probably a good indication that they are very healthy in terms of financials.
On the other hand, if you see some variations in the payout history, or even worse, dividend cuts, that might be a sign of financial weakness. Of course, the company's maturity has a lot to do with this, so that's why it's so important to have as much information as possible when making these investment decisions.
Investors using tools like Wisesheets (literally) have everything they need at their fingertips.
A common misconception
There's a crucial distinction that we must be able to make.
And unfortunately, most investors confuse these two terms. It's the difference between the payout ratio and the dividend yield. They are not the same.
You know that the dividend payout ratio formula tells us the percentage of net income paid as dividends. But when we're talking about the actual dividend yield, that is the percentage of the share price being annually paid as a dividend.
So, the dividend yield can be found by dividing the annual dividend by the price per share. They're two simple formulas with one common misconception.
At the end of the day, they tell us two totally different pieces of (valuable) information!
Final thoughts
Dividends are great, there's no doubt about it.
They're essential to any investment portfolio, which means it makes sense to study them tirelessly. You have already learned one of the most important aspects.
The dividend payout ratio formula.
The thing is, if you know how to calculate it, you can stay one step ahead of the crowd. Remember, it's found by dividing the dividends paid by the company's net earnings. Keeping a close eye on this metric will give you a great idea of their financial health, so it's worth memorizing.
Creative investors who work smarter, not harder (and take advantage of modern tools) have quite the edge over the rest of the market.
It takes one good decision to change your life.
