Thoughts on Calculating Dividend Payout Ratio

by: The Dividend Guy

We’ve been questioned regarding all of the dividend data that we use to analyze different stocks when we try to find the top choices (see our Top US Dividend Stocks and Top Canadian Dividend Stocks), especially about the payout ratio. It seems simple enough, but one reader was (rightfully) confused about seeing different numbers between two websites and was wondering which one was right and what could cause these differences. It seemed like the answer might be of interest to quite a few readers so we decided to publish it here.

What is a payout ratio?

The payout ratio is simply the portion of a company’s earnings that it chooses to pay out as dividends. Here's what it would look like as an equation:

  • Payout ratio = dividends / earnings

Or

  • Payout ratio = dividend per share / earnings per share

How could anyone get It wrong?

Not that simple

However, there are many different aspects that make the calculation of this ratio much trickier than you could initially think. We decided to take a few and hopefully that will help you better understand the numbers and how to interpret differences between data sources for the payout ratio.

Leading or trailing dividends?

If you have a dividend portfolio, you hopefully hold a majority of stocks that are raising dividends in a consistent way. The question would become, what number would you use in the formula above as this company is raising dividends. For example, suppose, as we have here, 2010-Q4 and 2011 are your best estimates.

Quarter Dividend Per Share
2010-Q1 $0.20
2010-Q2 $0.22
2010-Q3 $0.22
2010-Q4 $0.24
2011E-Q1 $0.24
2011E-Q2 $0.26
2011E-Q3 $0.26
2011E-Q4 $0.28
Click to enlarge

Would you use a dividend per share of:

$0.88 (realized dividends last year)
$0.96 (last dividend annualized)
$1.04 (actual dividend expected in 2011)

You could make a case for all 3 and I can tell you that there is no “right” answer. Some use each one of those numbers and as you can imagine, it can make big differences.

Leading or trailing earnings?

The same situation occurs for earnings but the effect can be even more dramatic. Why? Because earnings tend to fluctuate and one “fluke” quarter with a big loss or a big gain can make a world of difference. In our case, here are the earnings:

Quarter Earnings Per Share
2010-Q1 $0.68
2010-Q2 $0.75
2010-Q3 -$2.24
2010-Q4 $0.82
2011E-Q1 $0.82
2011E-Q2 $0.88
2011E-Q3 $1.33
2011E-Q4 $0.95
Click to enlarge

Would you use an earnings per share of:

$0 (realized last year)
$3.26 (last dividend annualized)
$3.98 (actual dividend expected in 2011)

This one is much more difficult to judge but I would personally say that you tend to take out “extraordinary events” and use a number that is as representative as possible of what can be expected in the future.

Special dividends?

Many companies occasionally pay out special dividends for various reasons. These are certainly nice to have but it’s difficult to “assume” they will be paid out in the future and counting them in the payout ratio or any other dividend statistic can be a difficult decision. For some companies, the “special dividends” are a big part of their payout every year, especially in funds that pay out most of their earnings. They will pay a conservative dividend for the first parts of the year and then pay out excess earnings at year’s end.

Errors

Researching this type of financial data as well as manipulation to include or exclude special factors certainly opens the possibility for human error. On all of our analysis we do our best to double check everything but we are always more than happy to look into specific numbers, you can simply contact us.

Which one is right?

In the specific case that the reader above was looking into, the other source was a well known newspaper which seemed to be off. I’m not sure what caused the problem but it could simply be a different method, different estimates or even a different analysis. As always, we recommend that you do your own research!