What to make of a company's payout ratio?
- Thread starter Newbunymo
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First, see where them dividend money is coming from.
If it's mainly debt and borrowings... see if that's reasonable given their current situation.
Better if divvies are from profit earned. Better yet, if no divvy at all.
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Really you want the pay out ratio to suit the companies investment opportunities.
Eg, if the company has low risk ways of deploying the cash where it can earn 15% on the funds it retains, then It makes sense for the company to retain a large portion of earnings, due to the fact that $1 of retained earnings will probably end up adding more than $1 to market cap over time.
If the company is in a poor business, where it can only earn 5% on funds it retains, you want it to pay out as much of the earnings as it can, because $1 of retained earnings will probably ad less than $1 to market cap.
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It depends
Serious.
If all else equal, then obviously the higher the better. But everything is not the same...
You would need to see if the yield being paid is "reasonable"; if reasonable, is it stable; can the company afford it; should it invest that somewhere else.
Some company will keep the yield high and stable... So that a quick look will suggest it's a good thing. It might be but if, say, earnings barely cover the dividends and it constantly borrows to repay interests.
In short, you have to understand the stock as a business. Not analyse it using mathematical ratio - not in isolation.
So use ratios and parameters as a guide to filter and drill down to the company you can understand. Once it narrows down, put context and put yourself in the seat of the manager to see if these policies are reasonable or not given the company's situation.
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You can try and analyze from where the dividend is coming from. Usually it is from debt or borrowings. Analyzing payout ratio and other financial and leverage ratio helps a trader to understand in a better manner whether to invest in its stocks or not.
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If the compay is paying out part of the profits as dividends then that's not unreasoanble especially if they're already a dominant player in their industry or for some other reason can't effectively deploy additional capital to expand the business at least without taking on greater risks. Giving it back to shareholders makes good sense in that situation.
On the other hand, if they're borrowing money or running down the business in order to hand out cash then that rings quite a few alarm bells since it's clearly not a sustainable situation to be in. Possibly OK if it's short term depending on the circumstances but it's not a long term strategy that's going to end well if nothing changes.
On the other hand, if they're borrowing money or running down the business in order to hand out cash then that rings quite a few alarm bells since it's clearly not a sustainable situation to be in. Possibly OK if it's short term depending on the circumstances but it's not a long term strategy that's going to end well if nothing changes.
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