Corporate dividend Policy, Dividend Payout and Dividend Yield

Corporate Dividend is determined by the companies Board of Directors. Are high dividen

In determining dividend policy and dividend payout: When should companies pay dividends?, you learned that,"a company should only pay dividends if it is unable to reinvest its cash at a higher rate than the shareholders of the business would be able to if the money was in their hands. If company ABC is earning 25% on equity with no debt, management should retain all of the earnings because the average investor probably won't find another company or investment that is yielding that kind of return.

At the same time, an investor may require cash income for living expenses. In these cases, he is not interested in long-term appreciation of shares; he wants a check with which he can pay the bills. This investor must evaluate each companies dividend policy.

Double taxation-the political debate over dividends

Dividends, like interest, are taxed at a person's individual tax rate. Capital gain taxes, on the other hand, are assessed according to the length of time an investor held his investment and can be as low as half the rate levied on dividend income. This difference in tax treatment is another reason many investors opt for long-term equity holdings that reinvest capital into the business instead of paying it out in the form of a dividend; by avoiding the double-taxation, they can compound their wealth at a faster rate.

There is a significant political controversy over the fact that profits paid out as dividends are subject to double-taxation. The corporation paid income taxes on the profit it earned(original tax). The owners of the business then take that profit out for their personal use in the form of a dividnd and are taxed at personal income tax rates(second tax). In effect, they have paid the government twice.

The proponents of the dividend tax argue that the wealthy, by definition, own significantly more investments than the poor. Therefore, it would be possible for someone to earn billions of dollars in dividend income and not pay a dime in Federal taxes. This, they say, is inherently unfair. The gap between the rich and the poor would explode over night.

Dividend Payout Ratio

The percentage of net income that is paid out in the form of dividends is known as the dividend payout ratio. This ratio is important in projecting the growth of company because its inverse, the retention ration (the amount not paid out to shareholders in the form of dividends), can help project a company's growth.

Calculating Dividend Payout Ratio

Coca-Cola's 2003 cash flow statement shows that the company paid $2.166 billion in dividends to shareholders. The income statement for the same year shows the business had reported a net income of $4.347 billion. To calculate the dividend payout ratio, the investor would do the following:

$2.166 dividends paid / $4.347 reported net income = 49.8% This tells the investor that Coca-Cola paid out nearly 50% of its profit to shareholders over the course of the year.

Dividend Yield

The dividend yield tells the investor how much he is earning on a common stock from the dividend alone based on the current market price. Dividend yield is calculated by dividing the actual or indicated annual dividend by the current price per share.

Staples Inc. pays an annual dividend of $7 and trades at $910 per share. Hollins Inc. pays an annual dividend of $2.72 and trades at $49.75 per share. By calculating dividend yield, the investor can compare the amount he would earn in cash income annuallyfrom each security.

Staples Inc. Yield Calculation

$7.00 / $910 = 0.0077 or 0.77%

Hollins Inc. Yield Calculation

$2.72 / $49.75 = 0.055 or 5.5%

In other words, despite the fact that the Staples Inc. pays a higher per-share dividend, $100,000 invested in its common stock would yield only $770 in annual income as opposed to the same amount invested by Hollins Inc. which would yield $5,500, An investor interested in dividend income and not capital gains should opt for the latter dividend policy, all else being equal.

Selecting High Dividend Stocks

An investor desiring to put together a portfolio that generates high dividend income should place great scrutiny on a company's dividend payment history. Only those corporations with a continous record of steadily increasing dividends over the past twenty years or longer should be considered for inclusion. Futhermore, the investor should be convinced the company can continue to generate the cash flow necessary to make the dividend payments, a handgun manufacturer, for example, may have a long history of high dividend payments while generating strong cash flow from operations yet not make a good investment because it faces litigation which, if successful, will bankrupt the business.

Dividends Related to Cash Flow- Not Reported Earnings

This brings up an important point dividends are dependent upon cash flow, not reported earnings. Almost any Board of Directors would still declare and pay a dividend if cash flow was strong but the company reported a net loss on a GAAP basis. The reason is simple: investors that prefer high dividend stocks look for stability. A company that lowers its dividend is probably going to experience a decline in stock price as jittery investos take their money elsewhere. Companies will not raise the dividend rate because of one successful year, so afraid are they of lowering the dividend they will wait to see if the business is capable of generating the cash to maintain the higher dividend payment forever. Likewise, they will not lower the dividend if they think the company is facing a temporary problem.

Debt Restrictions

Many companies are not able to pay dividends because bank loans, lines of credit or other debt financing places strict limitations of the payment of common stock dividends. this type of covenant restriction is disclosed in a company's 10k filing with the SEC .

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