The idea behind the Payout Ratio (dividend per share/earnings per share) is great, but doesn't provide empirical results that justify the headache of individual stocks.
The dynamics of dividends are significantly more complicated than two metrics in a ratio. Earnings are a huge factor, but a company also funds itself through long-term debt. Dividends paid are obviously a factor, but capital expenditures should be the first priority for using capital.
A dynamic payout ratio which better analyzes a company’s ability to increase dividends is needed to fulfill due-diligence requirements.
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Hi 800,
Can you elaborate on what you mean by a dynamic payout ratio? A low payout ratio and high DGR are attractive, but obviously they have to be taken in context of other financial metrics, such as what the company earns on the money it reinvests. I'm also curious to hear your thoughts on debt relates to the payout ratio.
Welcome to the forum, and please don't hesitate to let us know about your background on the introduction forum.
Hi ETD! Cool name and thanks for the warm welcome! I can't believe I didn't find this place earlier. I'm all about DG!
My thought on a more dynamic payout is NOT organically my idea... I just found a way to rank the market with an idea I stole from Lintner. Basically, a genius prof named Lintner interviewed something like 500 board of director members on dividend policy. Lintner came up with the formula, "Operating Income + Change in Long-Term Debt = Capital Expeditures + Dividends." I use the formula more as a ratio... so, (Operating Income + Change in Long-Term Debt) / (Capital Expeditures + Dividends). I then rank the market according to this ratio and only accept the the top 35% of the market.
I'm not so foolish as to use that ranking alone. I test the operating income on a number of measures. The formula can interpret an increase in debt as a good thing, which I don't disagree with... Additionally, I have no problem with transferring wealth from debt holders to stock holders. However, issuing high yield debt for a dividend is totally reckless, so I also do a credit analysis. Spending less on capital expenditures can make the formula look better, however skimping on capex will most likely hurt the business. So, I make sure that capex is greater than depreciation, as reported on the statement of cash flows. The only thing I require from dividends is the current yield must be greater than the yield-to-maturity of the 10-year t-notes.
There's a few other things I do in my due-diligence, and I'm getting better every day. I'm getting a lot of good results in my portfolio, in the form of total return, low turnover, and dividend increases.
