Dividend Payout Factor – What It Means to Me?


In one of my earlier posts, I discussed whether a given company should pay dividends. I presented my thoughts and observations on the rationale that developing business does not provide dividends, while mature businesses are more inclined to give dividends to shareholders. I also mentioned that both sides of the arguments are correct and individual investors need to look at from their own investment objectives and risk profile.

Here in this post, I am continuing the discussion on Should Companies Pay Dividends? from the context of payout factor.

Payout factor is the ratio of dividends per share divided by earnings per share. In essence what this means is a percentage of earnings (or profits) that is shared with common shareholders. In an ideal scenario one would expect that all of the company’s earnings are shared with the shareholders. Believe it or not, that is not a good business strategy. Every business needs financial resources to continually grow/improve/develop product portfolio or market footprint. This can be done by borrowing money (i.e. debt – which is not good) or use some percentage or all of the profits. My personal thoughts are that companies should follow a balanced path which uses both of these sources. This is where the payout factor comes into play.

I believe irrespective of developing business and/or mature business; the companies should always share their earnings with shareholder. I like to look at this using an example. I have my own business which is profitable and generating income. It does not matter whether it is a developing business or a mature business. I would like to take out a given percentage of business’ earnings for my personal living expenses and personal consumption. If I do not do that, how long will I sustain without an income? I cannot keep plowing back my earnings into the business. I as a business owner will use sensible financial responsibility to mange my earnings. Same thought process goes with my investments in companies. If it is a growing business, the payout factor can be as low as 10% to 20%; otherwise for mature companies it should be as high as 40% to 50%. As a shareholder, knowing that management thinks about shareholders will keep me motivated to remain invested. The intangible benefit of this is that management is more likely to be financially responsible.

Some examples of companies with low payout factors are LOW, CAT, BNI, UTX, HON, ADM, SLB, and FLS. These are not necessarily dividend growth or high yield companies. However, they have significant presence, have competitive advantage, and sustainable business model in their market domain. If these companies are really growing and sustaining their earnings, then I can expect to get additional returns from capital appreciation.

In my dividend portfolio, such companies may play the role of low dividends with potential for capital appreciation. The key is when to invest in these companies. We dividend investors have lot of patience. So why not be patient and wait for the right opportunity. Markets are very cyclical, they go up and they go down. Eventually, every good company will come down at some point in time.

To summarize….

I invest or buy stocks only if the company gives dividends and payout factor is more than 10%. It is acceptable to have a low payout factor provided the company has good business fundamentals. If it does not meet the dividend growth criteria, then I may look at it as dividend + value investment or value investment alone. At the time of this writing, I am invested in LOW and CAT (for dividend + value) and BAC (for value).

2 Responses to “Dividend Payout Factor – What It Means to Me?”

  1. Dividend Tree says:

    VC:
    If I had a short term view (5 to 8 years) I would tend to agree with you that share value provides more buck for your money.

    My view is long term, 20+ years. Typically, dividends are paid from earnings/free cash flow – indicating continued profitability. Additionally, the a stable and consistent dividend growers will have higher share values (this is collateral benefit). Image if today BAC/C had same dividends as 2006/2007, what would their share value would be? Dividends are not only passive cash flow, it is also a measure corporations financial health.

    Thanks for stopping by and leaving contrasting viewpoint.

    Best Regards,

  2. VC says:

    There’s no way you’ll make as much money off dividends as you will if you own a share of a company and that company’s value increases. It’s not necessarily a good thing that companies provide dividends because it means there is that much less money for them to reinvest back into the company. And with less retained earnings, the business won’t be able to grow as much. If the money is reinvested, its more likely that the shares will go up, and you’ll make more money overall.

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