March 17th, 2012
by Guest Author Dee Gill, Y Charts
Companies with outsized problems sometimes offer outsized dividends to keep shareholders happy while their share prices don’t. So the key question for any investor chasing a stand-out dividend should be: how long can this company afford to pay me? This is where the cash dividend payout ratio comes in handy.
The ratio shows the portion of cash flow, after capital expenditures and preferred dividends payments, that a company uses to make its common stock dividend payments. (So the formula is common stock dividends/cash flow from operations – capital expenditures – preferred dividends paid.)
The cash dividend payout ratio is particularly useful for evaluating the staying power of dividends from companies undergoing massive business model overhauls. In recent years, for example, it became an important health check on old-fashioned telecom investments.
These companies own big businesses tied to dying services (land-line phones) and low- or no-growth services (such as broadband internet or cable subscriptions), so profits and share prices generally went down. The companies offer big dividends as incentives to investors to stick with them while they make acquisitions or build up other products that will make share prices grow again. Note that Verizon (VZ), the one furthest along in this process with a massive wireless operation, offers the lowest dividend.
But companies can’t indefinitely pay dividends that exceed free cash flow. Both Frontier Communications (FTR) and Alaska Communications Systems (ALSK) cut their dividends after their cash dividend payout ratios rose above one. Frontier shareholders got a 57% dividend decrease, while Alaska announced a 75% cut.
This ratio also is helpful in evaluating dividends at money-losing companies, which defy analysis using a traditional earnings payout ratio. That much more common payout ratio considers dividends as a percentage of net income. (Common stock dividends/net income). That usually works at healthy companies because they tend to use earnings to generate cash for dividend payments. But even strong companies hit the occasional money-losing year.
High-end kitchen supplier Williams-Sonoma (WSM) lost some money in the crunch of 2009, for example, but a check on its cash dividend payout ratio shows that there was little worry about its ability to pay its dividend then.
The cash dividend payout ratio is one of the premium analysis tools available to YCharts Pro subscribers.
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About the Author
Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts,stock ratings and portfolio strategies. YCharts® Pro offers proven stock ratings, data downloads, portfolio strategies and avanced stock screening. Free 14 Day Trial is available.