One may have encountered headlines that goes:
“ABC’s yield is now X%! Is it time to buy?”
Granted that most of such titled contents would provide an explanation and/or decision, at first glance, if X% is in the high ones or in double digits, I would be interested, too. However, let us remind ourselves the typical formula for dividend yield, and that is:
Dividend yield = Past 12 months’ dividend amount / Current price
Picture generated by Gemini.
Before I hit the “buy” button, I would be interested in ABC itself, and that means I would need to do some fundamental analysis on the company. Some of the financial figures I would look at are:
Dividend Growth Rate
A growing yield over time is tricky as the percentage could increase with both the dividend amount and price decreasing simultaneously, as the formula had shown above. A better metric to look at would be the dividend growth rate, i.e., the amount of dividends one gets last year versus the amount gotten this year. Percentages could mislead, but not the cash that is about to land on one’s hands.
Dividend Payout Ratio
The percentage of retained earnings earmarked for dividend distribution. Different companies have different dividend payout ratios, and some of them made it a policy to distribute at least a certain percentage. In the Bedokian Portfolio’s selection guideline, a payout ratio of above 25% is reasonable. However, if the payout ratio is more than 100%, though can be considered a red flag, one needs to dig deeper by looking at the cash flow statement (in the next section).
Dividends Paid in Cash Flow Statement
While a company paying out more dividends is a good thing for investors, another point to be aware is whether the cash flow of the company can sustain the dividend amount paid. Under the company’s cash flow statement, there is a line item called “Dividends Paid” or something similar; if this amount is very close to the free cash flow, and the dividend payout ratio is very high, then due consideration must be given. There is no point in exhausting the goose to its limit to produce more golden eggs in a short time.
In summary, a holistic approach is needed when looking at dividends and not be blinded by just the yield alone.
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