We may earn money or products from the companies mentioned in this post.
Successful dividend investors rely on many tools to help evaluate companies. One method often used is to find stocks on published lists such as the Dividend Aristocrat Index. This index includes stable companies that are well managed and have a strong history of increasing their dividends each year. Well known dividend payers like McDonald’s (MCD) and Coca-Cola (KO) are found on this list.
Other tools used by dividend investors to further screen stocks include several financial ratios that are specific to a company. For example, the dividend yield can be used to measure the cash flow an investor will get for each dollar they invest in a given stock. The price to earnings (PE) ratio can help tell an investor if a stock is overpriced in the current market.
Another important metric that is used by successful investors is the Dividend Payout Ratio. This calculation can help investors find companies that offer sustainable dividends that have the potential to grow each year.
What is the Dividend Payout Ratio?
The Dividend Payout Ratio (DPR) of a stock is the percentage of company earnings that are used to pay shareholder dividends. Also known as the payout ratio, this calculation informs investors how well a company’s earnings can support future dividend payments.
The DPR can be a useful stock screening tool to determine if a company’s dividend is sustainable. For example, a company with a 100% or greater payout ratio is paying out more in dividends than it is earning. While there are certain situations when the DPR can be ignored (ie. REITs and Trusts), overall it can be a helpful way to screen for companies that have sustainable dividends.
Let’s take a closer look at how to calculate the Dividend Payout Ratio.
How to Calculate the Dividend Payout Ratio
The Dividend Payout Ratio (DPR) is actually very easy to calculate. The ratio is calculated by dividing a company’s annual dividends per share by the earnings per share (EPS) for the same period of time. This information can easily be found from your online broker as well as on most financial web sites like Yahoo Finance.
Dividend Payout Ratio = (Annual Dividend per Share / Earnings per Share) * 100
Calculating the DPR
Let’s take a look at a real example of how to calculate a company’s DPR from one of my current holdings.
To see all of my current dividend stocks holdings, please refer to the Money Sprout Index.
Johnson & Johnson (JNJ) is a member of the Dividend Aristocrat index and has been consistently raising dividends for over the past 50+ years. At the time of this writing, the company paid an annual dividend of $2.64 per share. For the trailing 12 months, the company reported earnings per share of $4.81
To calculate the Dividend Payout Ratio for JNJ, we can plug our numbers into the equation above as follows –
DPR = ($2.64 / $4.81) * 100
The end result is a DPR = 54.89%.
As you can see, JNJ is currently using almost 55% of its earnings to payout dividends to shareholders. Certainly not a bad number for a company as established as Johnson & Johnson.
Note – The Dividend Payout Ratio can often be found right along with other important metrics of a company on financial websites. However, it can be helpful to calculate it on your own to understand where the numbers are coming from.
The Dividend Payout Ratio is the percentage of annual dividends paid by a company from its reported earnings. The DPR can be calculated by investors or can normally be found on most financial websites or online brokers.
Many successful investors use the DPR to help them filter out stocks that may not offer a sustainable dividend. While an important metric, this ratio should be used in combination with other criteria when screening stocks.
Full Disclosure – At the time of this writing, I owned shares in the following stocks mentioned in this article – MCD, JNJ, and KO. This is not a recommendation to buy these companies. Investors should do their own due diligence before deciding to buy or sell a stock.