Friday, October 08, 2010

Payout Ratio

Payout ratio is simply Dividend Per Share (DPS) divided by Earnings Per Share (EPS), which tells you how much buffer does the company have for it to increase its dividends. E.g. EPS for Singtel is about 22c and DPS is 11c on average for the last few years, so the payout ratio is 50%.

But what is a good payout ratio?

If the payout ratio is 30-40%, which I would say is probably below the global average, then you know the company has some room to increase dividends.

If the payout ratio is close to 100%, ie the company is paying everything that it earned as dividends, then we cannot expect a lot of growth in dividends unless earnings is going to grow significantly.

In Singapore, sadly, a lot of high dividend stocks also have very high payout ratio, ie no further room for dividend to grow unless earnings can grow. But if earnings can grow, then the firm would want the money to invest in growth and not return them to shareholders. Hence high dividend plus strong growth is an oxymoron. These stocks don’t exist. Or they are very rare.

When dividend and payout ratio both gets too high, dividend cut becomes inevitable.

However, cutting dividend is a big deal for many companies in Singapore, bcos a lot of shareholders buy Sg stocks mainly for their dividend and if it is cut, it means disappointment and selling pressure. Of course it also shows that management is not capable of steering the business well enough to pay their shareholders.

In fact, it got so important to the extent that some companies actually issued debt to pay dividends!

The two prominent cases being Singpost and Starhub.

In the early years when Singpost was listed, it was obligated to pay a high dividend yield for some reason that I forgot. So while Singpost’s net profit was just over S$100mn, it has to pay S$300mn in dividends! So bo pian, raise debt to pay dividend. However, that only happened more than 6-7 years ago and the company hasn’t done anything stupid like that ever since.

Ok let’s talk about Starhub.

For the past few years, Starhub generates annual net income of roughly S$300mn and pays roughly $300mn in dividends as well! At the same time, the firm increases its debt holdings almost every alternate year, in 1 year by as much as S$600mn! So people asked questions like why do they raise so much debt when they could have cut the dividends to save money?

Well I guess there are no easy answers. But if we analyse the cashflow statement of Starhub, we can see that perhaps the situation is not as bad. So it might be worthwhile to look at free cash flow vs dividend paid instead. Which is what I would do in the next post!