Investors can profit in the stock market through two primary channels: stock price appreciation and dividend payouts. Dividends provide valuable additional income and liquidity, particularly for income-seeking investors.

If you are one of these investors, the key to successful investing is to check for the quality and sustainability of dividends. Companies must have a healthy balance between dividend payouts, manageable debt levels, and ongoing company earnings growth to qualify high in terms of the sustainability of dividends. Also important is the price at which you buy the stock vis-à-vis the dividends.

Here are some ratios to check before you zero in on your next dividend-paying stock.

Dividend Yield Ratio

The dividend yield ratio tells what portion of the stock price the investors may get annually as dividends. The ratio is the division of the annual dividend per share by the current price per share.

For example, one of the high dividend-yielding companies is IOCL (Indian Oil Corporation), with a dividend yield of 7.17 per cent, which is ₹12 (annual dividend) divided by ₹167.23 (last week’s closing price).

The consistency of dividends depends on the consistency of earnings. Along with yield, consider factors like the company earnings, industry trends, performance against benchmarks, and investment goals.

However, it needs to be noted that the dividend yield here reflects only the trailing dividend yield, and past performance is no guarantee of the future. Hence, it is also important to check whether earnings will keep growing, as dividends can keep growing/sustain only if earnings keep growing/sustain.

Dividend Payout Ratio

The dividend payout ratio depends on a company’s level of business maturity. It shows how much of the company’s earnings are paid out to the shareholders. This ratio is computed by dividing the annual dividends by the annual net profit.

While there is no hard and fast rule, anything between 10 and 35 per cent may be considered a decent payout range. This range indicates that a company has just started paying dividends and is focusing more on investing earnings in expansion and R&D.

If the dividend payout ranges between 35 per cent and 55 per cent, it is considered healthy.

For example, Coal India’s recent payout ratio was 42 per cent in FY2024, compared to 53 per cent and 60 per cent in FY23 and FY22.

The decrease in payout this year might be due to CIL’s focus on expansion, as CIL is upgrading mechanized coal transportation and loading systems under FMC projects. The company aims to set up 3GW capacity of solar power projects to become net-zero by FY 25-26. It intends to add another 2 GW of renewable energy, aiming for a total installed capacity of 5 GW.

The payout range of CIL in the last 10 years has been between 40 and 146 per cent which places it on the list of dividend aristocrats in India.

Investors should look out for a healthy payout ratio.

Dividend Coverage Ratio

This is the inverse of the dividend payout ratio, which is computed by dividing the annual net profit by annual dividends.

For example, ITC’s dividend coverage ratio declined to 1.03 per cent in FY24 compared to the previous two years, which were at 1.24 per cent in FY23 and 1.13 per cent in FY22. This factor limits ITC’s ability to comfortably to cover/increase dividend payments solely from net income.

Investors should consider the dividend coverage and payout ratios to assess a company’s commitment to sustainable dividend payments. While the dividend payout and dividend coverage ratio are computed using the same metrics, the payout ratio gives a perspective on how much the company is investing in future growth, while the coverage ratio gives a perspective on the sustainability of dividends.

Alongside these ratios, investors must also check metrics like debt/equity ratio to ensure company is not overleveraged, before zeroing in on a dividend stock.

The author is an intern with bl.portfolio

Related Topics