Dividend payout ratio – and why it’s more important than a high dividend yield

If you love income stocks that pay a high dividend yield, then you ought to know about this one important ratio – the dividend payout ratio.

The dividend payout ratio is the percentage of a company’s profit that is paid out as dividends to shareholders. For example, if a company earns one million in profit and pays $500,000 as dividends, then its dividend payout ratio is 50%.

The dividend payout ratio can also go above 100%. So if a company earns a million and pays out $1.2 million, its ratio is 120% — which essentially means it paid out more than it earned in a given year. In the long run, a dividend payout ratio above 100% is not sustainable.

As an income investor, we want to invest in stocks that can pay a steady or growing dividend — even during a recession. The 2008/9 Global Financial Crisis was one of the worst recessions in recent history, but it was also a great time to evaluate which stocks were resilient enough to maintain a steady dividend during a crisis. In other words, a company that can maintain or grow its dividends in good or bad times is a great income stock.

A second chance at dividends?

Some years ago, I remembered that Second Chance Properties was widely touted as an income stock that paid a very attractive annual dividend yield between 8% to 10%. Not only that, Second Chance was one of the few stocks that increased its dividend per share (DPS) by 16.7% from 2.4 cents to 2.8 cents in 2009 — right in the middle of the Global Financial Crisis!

 2007200820092010201120122013
Dividend per share (cents)2.22.42.83.03.23.23.4

Second Chance Properties Dividend Per Share (2007-2013)

Due to its impressive track record and high yield, this stock naturally attracted many income investors. So let’s say you invested in Second Chance in 2013, you’d be happy to know that your DPS grew further to 3.5 cents in 2014 and then 3.6 cents in 2015 — which translated to a hefty 8.5% dividend yield.

Over the next two years, however, you’d find yourself very disappointed with Second Chance founder and CEO Mohamed Salleh — not because of his failed Singapore presidency bid in 2017 — but because Second Chance cut its dividend by more than 90% in 2016 and 2017.

 2011201220132014201520162017
Dividend per share (cents)3.23.23.43.53.60.20.3

Second Chance Properties Dividend Per Share (2011-2017)

Normally, such a sharp fall in dividends is often accompanied by a substantial fall in earnings. But Second Chance’s EBITDA (earnings before interest, tax, depreciation and amortisation) only decreased marginally by 3.3%.

So what caused Second Chance’s massive drop in dividends? It was its unsustainably high dividend payout ratio.

 20102011201220132014
Dividend per share3.03.23.23.43.5
Earnings per share*4.83.52.82.21.9
Dividend payout ratio63%91%114%155%184%

*Income from fair value gain/loss from investment properties and financial assets are excluded as these are one-off items.

As you can see, Second Chance’s payout ratio for three years, from 2012 to 2014, were far above 100%. Such a high dividend payout ratio is a red flag for savvy investors because it is unsustainable in the long run. But a less experienced one would have probably skipped this and been tempted by the high dividend yield on offer.

Do note that it is important to remove any exceptional items that are one-off in nature and may distort a company’s earnings and, hence, its dividend payout ratio. When there’s a one-time gain, this artificially inflates a company’s earnings and thereby lowers its dividend payout ratio (when it should be higher). Similarly, a one-time loss deflates earnings and raises the payout ratio (when it should be lower).

For example, I removed Second Chance’s one-time gain of nearly $3.4 million in 2014 to calculate its dividend payout ratio for the same year. (And it was still above 100%!)

Source: Second Chance Properties 2015 annual report

The fifth perspective

Using a stock filter tool, here is a non-exhaustive list of SGX and Bursa Malaysia stocks that had payout ratios above 100% in 2017:

SGXPayout ratio Bursa MalaysiaPayout ratio
STARHUB101.4%7-ELEVEN MALAYSIA100.1%
FRASERS LOG101.9%ASTRO MALAYSIA100.2%
FU YU LTD107.2%BOUSTEAD PLN-ORD101.8%
UTD ENGRS112.7%SELANGOR PROP102.0%
CHUAN HUP HLDGS112.8%UCHI TECHNOLOGY102.3%
UMS HOLDINGS114.0%TONG HERR RESOUR102.6%
WING TAI HLDGS115.7%TELEKOM MALAYSIA104.1%
VICPLAS INTL LTD117.2%ATLAN HOLDINGS104.6%
BT S'WANG EST117.9%CARLSBERG BREW107.4%
OUE COMMERCIAL119.3%IGB REIT109.5%
GLOBAL PALM RES120.5%FORMOSA PROSONIC109.6%
HIAP SENG ENGRG122.9%BRITISH AME TOBA110.0%
WHEELOCK PROP123.0%FIMA CORP BHD111.9%
DUTY FREE INTL124.0%APOLLO FOOD112.2%
SECURA125.8%BERMAZ AUTO BHD113.9%
CHEMICAL IND.128.5%KRETAM HOLDINGS115.5%
IFAST CORP LTD134.3%TALIWORKS CORP133.3%
NSL LTD134.5%AMCORP PRO BHD134.8%
GENTING SPORE135.3%HONG LEONG IND135.0%
GLOBAL INVEST136.4%CYL CORPORATION137.1%
NERA TELECOM139.7%ENG KAH CORP145.7%
VIVA INDUSTRIAL142.4%SEG INTL159.1%
RYOBI KISO HLDGS148.1%PAOS HOLDINGS159.6%
SHANGHAI TURBO148.8%GOPENG BERHAD161.6%
BBR HOLDINGS163.7%PRESTARIANG BHD163.1%
HUPSTEEL170.1%TASEK CORP ORD169.0%
KING WAN CORP174.0%JCY INTL BHD177.2%
HOCK LIAN SENG177.4%MAJUPERAK HLDGS204.9%
GLOBAL TESTING196.4%SIME DARBY BHD209.4%
KARIN TECHNOLOGY208.1%ALUMINIUM CO233.5%
OLD CHANG KEE208.7%CHEMICAL CO MSIA244.1%
OVERSEAS EDU217.1%MERCURY IND BHD244.6%
FAR EAST HTRUST259.2%GLOBETRONIC TECH252.0%
VIBRANT GROUP263.3%PACIFIC & ORIENT261.7%
AF GLOBAL LTD273.5%TEXCHEM RES'RCES378.7%
JEP HOLDINGS283.2%GREENYIELD BHD450.3%
CDW HOLDING385.5%JMR CONGLOMERAT467.1%
SINGAPORE POST414.9%AMANAH HARTA541.9%
ASPIAL CORP442.7%IFCA MSC BHD586.6%
OUE HOSPITALITY473.8%MALAYSIA AIRPORT2085.7%
THAKRAL CORP618.7%

If you plan to buy (or already own) any of the stocks listed in the table above for its dividend, you don’t have to panic, but you might want to check on its dividend payout ratio and exceptional items. The thing with many stock filters is that they usually include exceptional items, which will distort the dividend payout ratio. There is no hard and fast rule for which item is exceptional or not, but if it is one-off in nature and highly unlikely to happen again, I would remove it.

So by simply checking a stock’s dividend payout ratio, you can avoid companies with high, unsustainable ratios — and focus only on the ones with a steady dividend and reasonable payout ratios.

Looking to invest for dividends? Dividend Machines 2018 is opening 26 Feb. Watch for it here…

Rusmin Ang is an equity investor and co-founder of The Fifth Person. His investment articles have been published on The Business Times BTInvest section and Business Insider. He has also been featured multiple times on national radio on 938LIVE for his views and opinions on how to invest successfully in the stock market. Rusmin is on the speaking circuit for CIMB Securities (Malaysia) and has spoken at events in Penang, Sibu and Kuala Lumpur and is the co-author of Value Investing in Growth Companies published by Wiley, Inc. The book can be found in all major book stores worldwide and on Amazon.com, Barnes & Noble and Apple's iBooks. Rusmin was actually a former SIAEC scholar who gave up his scholarship and a cushy career to follow his itch of learning how to be a better investor and ultimately lead a life of financial independence. He believes that anyone, even with a regular job, can achieve more financial peace-of-mind by investing intelligently and safely for the long term.

7 Comments

  1. jo

    February 20, 2018 at 7:39 pm

    pray tell us from where did these sg coys get the extra cash to pay the more than 100% dividend payout? some of them able to pay more bc of one-off gain, what about those that do not have one-off gain in 2017? from reserves built up over the years?

    • Rusmin Ang

      February 21, 2018 at 11:40 am

      If the earnings are not distorted by fair value losses (e.g. losses from property revaluation) or exceptional one-time losses, any excess payout should come from the company’s reserves or additional cash raised from the exercise of warrants, rights or placements.

      In some cases, the company may borrow from the bank to sustain the dividends. Again, we will need to analyse each company on a case-by-case basis and look into its earnings.

    • Bob

      February 23, 2018 at 8:57 pm

      Some REITS also have management fees paid out in the form of additional units rather than from property income.

  2. david

    February 21, 2018 at 10:51 pm

    If a company is cash rich or net cash company, it can afford to give more that 100% dividend payout instead of giving out special dividends or dividends thru capital reduction.

    So let say company A has extra net cash of 50cents per share. Instead of giving say 20cents per share as special dividends (one-time special dividend since extra cash is not needed for daily operation needs), they can simply give > 100% dividend payout every quarter or yearly and be able to sustain it for many years. So eg: declaring extra 2 cents dividend yearly, the 20 cents can last 10 years and not forgetting dividend from it’s daily operational profit. So is important that the >100% dividend payout comes from extra cash and not through borrowing from banks or rights issue.

  3. jo

    February 23, 2018 at 5:32 pm

    thanks all for taking the time to explain…

  4. Kay

    February 27, 2018 at 4:40 pm

    Which stock filter tool do you recommend?

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