Dividends: yield, payout ratio, dividend dates and sustainability
Calculate dividend yield and payout ratios, understand the dividend calendar, and judge whether a dividend is likely to be sustainable.
What you will learn
- How to calculate dividend yield, the earnings payout ratio and the free cash flow payout ratio
- The order of the dividend dates and what happens to the share price on the ex-date
- Four warning signs that a dividend may be cut
- Why a very high yield is often a signal of risk, not of value
Explanation
A dividend is a cash payment from a company's profits to its shareholders. Paying it is a decision, not an obligation: in a German stock corporation (Aktiengesellschaft, AG) the annual general meeting (Hauptversammlung) votes on the use of the profit, usually following the proposal of the management and supervisory boards. Many German companies pay once a year; many US companies pay quarterly.
Key ratios
- Dividend yield = dividend per share (DPS) ÷ share price. It shows the cash return at today's price, before taxes.
- Payout ratio = DPS ÷ earnings per share (EPS), or total dividends ÷ net income. It shows which share of profit is paid out.
- FCF payout ratio = total dividends ÷ free cash flow (FCF). Dividends are paid in cash, not in accounting profit, so this ratio is the harder test. Above 100% means the company pays out more cash than it generates and must use savings or new debt.
The dividend calendar
- Announcement / resolution: the company proposes the dividend; in Germany the AGM then decides.
- Last cum day: the last trading day on which a buyer is still entitled to the dividend ("cum" = with).
- Ex-date: from this day the share trades without the dividend. In Germany, the ex-date is normally the business day after the AGM.
- Record date: the day on which the custodian records who holds the shares and is therefore entitled.
- Payment date: the cash arrives in the account, after taxes withheld.
The exact gaps between these dates depend on the market and its settlement cycle, so always check the company's own announcement.
On the ex-date the share price usually opens lower by roughly the dividend amount, all else equal, because the company has less cash. A dividend therefore does not create wealth on the day it is paid; it moves value from the company into your account, and the cash may be taxed. German taxation of investment income is covered in the ETF course; for foreign shares, source-country withholding tax may apply and only part of it may be creditable in Germany. Check the current rules with a Steuerberater.
Worked example
Hypothetical example: Company D trades at €50. It pays a DPS of €2.00, has EPS of €2.50 and free cash flow of €1.60 per share. It has 200 million shares. Taxes and fees are excluded.
- Dividend yield = 2.00 ÷ 50 = 4.0%.
- Payout ratio = 2.00 ÷ 2.50 = 80%. High, but covered by profit.
- FCF payout ratio = 2.00 ÷ 1.60 = 125%. Total dividend = 200 m × €2.00 = €400 m; total FCF = 200 m × €1.60 = €320 m. The company pays €80 m more than it generates in cash.
Now assume bad news pushes the price down to €32 while the last dividend stays €2.00 in the data tables. The trailing yield shown on websites jumps to 2.00 ÷ 32 = 6.25%. If the company then halves the dividend to €1.00, the real yield on the new price is 1.00 ÷ 32 ≈ 3.1%. The attractive 6.25% was a backward-looking number.
On an ex-date: if Company D closes at €50.00 on the last cum day and pays €2.00, a neutral opening on the ex-date would be around €48.00. Real prices also move with news, so the drop is rarely exactly the dividend.
Common mistake
Four warning signs of an unsustainable dividend:
- FCF payout ratio above 100% for more than one year
- Rising debt used to finance the payment
- Falling earnings while the payout ratio climbs
- Payout well above that of close peers in the same industry
Practice activity
Hypothetical example: Company E trades at €80, pays DPS €3.20, has EPS €4.00 and FCF per share €4.40. On paper: (1) calculate yield, payout ratio and FCF payout ratio; (2) the price falls to €64 with no change in the dividend; what trailing yield is shown? (3) If the company then cuts DPS to €2.40, what are the new payout ratio and the yield at €80?
Show solution
(1) Yield = 3.20 ÷ 80 = 4.0%. Payout = 3.20 ÷ 4.00 = 80%. FCF payout = 3.20 ÷ 4.40 ≈ 73%. The dividend is covered by cash flow.
(2) 3.20 ÷ 64 = 5.0%. The business did not change; only the price did.
(3) Payout = 2.40 ÷ 4.00 = 60%. Yield at €80 = 2.40 ÷ 80 = 3.0%.
Limitations: one year of data says little; look at five to ten years of EPS, FCF and dividends before judging sustainability.
Key takeaways
- Yield = DPS ÷ price; payout = DPS ÷ EPS; FCF payout = dividends ÷ free cash flow.
- The ex-date price drop means a dividend is not free money.
- A dividend is sustainable only if cash flow, not just profit, covers it over several years.
- Treat an unusually high yield as a question to investigate, not as an answer.
Next step
Steady dividends require a business that can defend its profits; the next lesson explains business quality and competitive advantages, often called moats.
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