Dividend stock – Dividend payout ratio

Dividend stock   Dividend payout ratio compounding dividend reinvestment drips

An often overlooked metric to evaluate dividend paying stocks is the dividend payout ratio. How does it affect your dividends and share price performance?

If you compare Ascendas REIT versus Kingsmen Creatives, the dividend yield is 5.9% versus 5% its a no brainer which you would choose.

Assuming valuations, business model are largely similar, dividend payout ratio is one important consideration.

Dividend payout ratio is either dividend / earnings or dividend / free cash flow.

It tells you how much out of profits warned or cash flow received that the company can safely payout.

In the case of Ascendas REIT, like all Reits they are mandated to pay out greater than 90 percent of earnings, so their payout ratio is higher.

Kingsmen Creatives, on the other hand pays out 50% of earnings or free cash flow. This also means that if Kingsmen is not conservative they can choose to pay out 10% dividends and they will be alright.

If you were to evaluate to buy the stock assuming business model and valuation using other metrics are largely the same which would you choose?

If the yield is close, a low payout ratio versus a total payout is better because stocks go through good years and bad.

Lower payout buffers dividend cut in downturns

An investor looking for yield will feel safer that the yield he purchase for is intact. (to add to that, note I always evaluate in the worse case for a stock, what kind of dividend yield it can pay out, and whether it matches my expectation)

If earnings of Ascendas get slash 20%, dividends get impacted, it will probably be less so for Kingsmen.

Looking at it from the point of earnings and free cash flow, you can say we are comparing a 5.9% yielder to a 10% yielders which is why I always say as a dividend investor, know where dividend comes from (Ebitda, operating cash flow, earnings and free cash flow | read here)

Low payout reserves cash for smart or stupid capital allocations

Kingsmen, with its 50% payout ratio, can also carry out a more flexible capital allocation something which Ascendas REIT cannot.

Paying out 50% leaves ample cash to

  • retain on the balance sheet for rainy days
  • to pay off debts to reduce gearing
  • buy back shares to strengthen shareholders future dividends
  • purchase new technology or assets to improve competitiveness.

In the defense of Ascendas REIT, not all business requires capital expenditure to a large extent however having that flexibility would have allow Ascendas to improve balance sheet and shareholder value.

In the case of capital investments, a high Roe company with low payout can significantly improve shareholders future dividends as future earnings and cash flow grew faster than if it’s 100% paid out.

Assuming,

Year 1
Kingsmen Creatives
Starting Net asset value per share (NAV) = $1.00
Earnings per share (EPS) =$0.10 (10% of NAV growth)
Dividend payout ratio = 50%
Dividend per share (DPS) = $0.05
Consistent ROE = 10%
Ending NAV = $1 + $0.05 (retained earnings)
= $1.05

Ascendas REIT
Starting NAV = $1.00
EPS = $0.05
Dividend payout ratio = 100%
DPS = $0.05
Consistent ROE = 10%
Ending NAV = $1.00

Year 2
Kingsmen Creatives
Starting Net asset value per share (NAV) = $1.05
Earnings per share (EPS) =$0.105
Dividend payout ratio = 50%
Dividend per share (DPS) = $0.0525
Consistent ROE = 10%
Ending NAV = $1.05 + $0.0525 (retained earnings)
= $1.1025

Ascendas REIT
Starting NAV = $1.00
EPS = $0.05
Dividend payout ratio = 100%
DPS = $0.05
Consistent ROE = 10%
Ending NAV = $1.00

Year 3
Kingsmen Creatives
Starting Net asset value per share (NAV) = $1.1025
Earnings per share (EPS) =$0.11025
Dividend payout ratio = 50%
Dividend per share (DPS) = $0.055125
Consistent ROE = 10%
Ending NAV = $1.1025 + $0.055125 (retained earnings)
= $1.157625

Ascendas REIT
Starting NAV = $1.00
EPS = $0.05
Dividend payout ratio = 100%
DPS = $0.05
Consistent ROE = 10%
Ending NAV = $1.00

Year 4
Kingsmen Creatives
Starting Net asset value per share (NAV) = $1.157625
Earnings per share (EPS) =$0.1157
Dividend payout ratio = 50%
Dividend per share (DPS) = $0.05788
Consistent ROE = 10%
Ending NAV = $1.157625 + $0.05788 (retained earnings)
= $1.2155

Ascendas REIT
Starting NAV = $1.00
EPS = $0.05
Dividend payout ratio = 100%
DPS = $0.05
Consistent ROE = 10%
Ending NAV = $1.00

Year 5
Kingsmen Creatives
Starting Net asset value per share (NAV) = $1.2155
Earnings per share (EPS) =$0.1215
Dividend payout ratio = 50%
Dividend per share (DPS) = $0.06077
Consistent ROE = 10%
Ending NAV = $1.2155 + $0.06077 (retained earnings)
= $1.2762

Ascendas REIT
Starting NAV = $1.00
EPS = $0.05
Dividend payout ratio = 100%
DPS = $0.05
Consistent ROE = 10%
Ending NAV = $1.00

The end result is that the net asset value of Kingsmen would have grown, and greater future earning power. As NAV grows so will the share price if the market realises its value.

The dividend payout grows as well.

Although the Roe for ascendas is good, there is no way to take advantage of it unless Ascendas leverages up or ask for a rights issue. The reit can carry out a private placement as well.

Ascendas was able to grow via appreciation of assets acquired mainly through debt leveraging after initial years of rights issue.

In a way, you can look at rights issue as thee reit taking back part of the 100% payout to fund its acquisition. This essentially feels like financial engineering.

Which would you prefer? A company that does not ask for cash and grows on its own or one that pays out all to you only to ask for money back?

Conclusion

The case is strong for buying stocks with a lower payout.

The caveat is that the assumption of shrewd capital deployment needs to take places.. Many companies were unable to take advantage of this because shrewd capital allocation is not always going to go your way.

If it does you get the kind of return you see for Dairy farm, SembCorp Industries (SCI’s increasing div|read here) and Keppel Corp (Keppel’s 700% return|read here).

I am sure their share holders are not complaining about the low dividends around 2-4% if the growth rate for the dividends is around 20% per year.

I run a free Singapore Dividend Stock Tracker available for everyone’s perusal. Do follow myDividend Stock Tracker which is updated nightly  here.
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  • Douglas Lee

    As always, very good article.

  • Aa

    That’s why i am still puzzled as to how Starhub pays their dividend

    Their payout ratio is more than 100%

  • Drizzt

    hi Aa,

    its ok because most of my examples were using earnings. it depends on your metric of safety. Free cash flow is the cash flow earn from business sans capex. For starhub case their dividends is still below free cash flow.

  • Drizzt

    hi Douglas,

    Thanks!

  • Aa

    But wouldn’t starhub eventually run out of this free cash flow after a few years? or unless their earnings per share can match their payout?

    Starhub has good yields, but looking at their payout for many years, if they cannot increase their EPS, i don’t see how they are going to pay out the same dividends in future

  • Drizzt

    actually i hope you are not confusing free cash flow with cash holding.

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