Invessential

3 Steps to Analyzing a Company's Dividend

Vineel Bhat   |   6/28/21

Income investors love dividend stocks, but not all are attractive or safe. Companies may be paying a fraction of what an investor is looking for, be on the verge of a dividend cut, or growing dividends at a rate lower than inflation. Knowing the ins and outs of a company’s dividend before investing is crucial for any dividend stock – especially for more established, slow growing businesses who distribute the majority of their profits back to shareholders.

Analyzing dividends is a three pronged fork: yield, payout ratio, and growth, each of which provides different insights.

Dividend Yield

Dividend yield represents a company’s dividend as a percentage of the share price. Aka how large the dividend is in comparison to what you have to pay for it. The table below outlines the dividend yield of a couple dividend stocks.

Ticker Stock Name Dividend Yield
MO
Altria Group
7.22%
DUK
Duke Energy
3.86%
INTC
Intel Corp.
2.49%
AAPL
Apple Inc.
0.66%

Tobacco company Altria Group tops the list at 7.22%, followed by Duke Energy at 3.86%, Intel at 2.49%, and Apple at 0.66%. If you’re specifically looking for a business to provide large passive income up front, low yielders like Apple probably won’t be the best bet. Meanwhile Altria especially appeals to income investors due to its massive yield, at which you would make your money back within at most 14 years assuming no dividend cuts. However, beware of yield traps – where the dividend seems phenomenal due to high dividend yields, but is in reality unsustainable over a long period of time. Here’s where the payout ratio comes in.

Payout Ratio

Payout ratio represents the percentage of profits that a company pays out in dividends. E.g. a payout ratio of 50% would mean that the company pays 50% of profits to shareholders as dividends.

A payout ratio above 100% is a huge red flag – since that means the business is paying out more than it’s earning. In this case, dividends have to come out cash reserves and that won’t last long. Thus, payout ratios of over 100% in businesses that didn’t have a 1-off bad year in terms of profits, can signal a dividend cut.

Yield and payout ratio are corelated to an extent, but purchasing a dividend stock with a high yield plus a low payout ratio is ideal since that allows for great passive income in combination with capital appreciation potential.

Below are the same stocks from before but with payout ratio added in.

Ticker Stock Name Dividend Yield Payout Ratio
MO
Altria Group
7.22%
146.15%
DUK
Duke Energy
3.86%
223.26%
INTC
Intel Corp.
2.49%
30.06%
AAPL
Apple Inc.
0.66%
18.34%

Note that both Altria and Duke’s above 100% payout ratios are due to special circumstances. In the case of Altria, large tax write offs lowered profits; the payout ratio on a free cash flow basis comes down to 78.21%. And with Duke, the COVID-19 pandemic slammed profits, but those are expected to rise to levels above pre-pandemic levels in the 2021 fiscal year.

In normal years, Altria and Duke would both have payout ratios hovering in the 70s. So pretty much all of these stocks are safe from a dividend cut in the foreseeable future. However, companies like Apple and Intel may post higher capital appreciation in comparison to Altria and Duke since they still have a majority of profits leftover to reinvest back into the business. Companies with low payout ratios also have the potential for payout ratio expansion in the future when growth opportunities dry up and diverting funds to dividends is a better way to provide shareholder value. 

Dividend Growth

Dividend growth refers to trends in dividend payments over time. Generally, long-term dividend growth at a compounded rate greater than 6% is ideal to be growing a healthy amount above inflation. Fast growing companies with lower payout ratios can grow dividends at an even faster pace, but come with lower yields.

Ticker Stock Name Dividend Yield 5y Dividend CAGR
MO
Altria Group
7.22%
9.50%
DUK
Duke Energy
3.86%
3.35%
INTC
Intel Corp.
2.49%
6.58%
AAPL
Apple Inc.
0.66%
9.73%

Adding in dividend growth to our table, Altria seems to post the most attractive dividend with a massive yield and phenomenal 9.50% growth rate. However, past performance doesn’t indicate future growth. I’d expect a company like Apple to grow dividends at a much higher rate than Altria over the next 10 years – while Altria’s forward payout ratio is getting close to their long-term target of 80%, Apple has much more room to hike dividends as growth opportunities dry up. But the starting yield with Apple only comes in at 0.66%, and that’s the trade off. On a purely dividend basis, Altria would be suited for income investors seeking a high starting yield, Apple would be suited for dividend growth investors seeking income and capital appreciation, and Intel is somewhere in between both of these.

Conclusion

Yield assesses the current dividend size, payout ratio assesses dividend safety, and growth assesses hikes in dividend payments which could lead to an increasing yield on cost down the road. Analyzing dividend growth in tandem with yield and payout ratio completes the trio of metrics that provide a full range of insights into a company’s dividend, and which can together help you make a decision on whether or not a dividend stock is worth it.

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Disclaimer: Opinions not advice! I am not a registered financial advisor. All views and recommendations expressed in this article are solely my opinions and should not be considered as financial advice.