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Dividend Paying Stocks: The 3 Simple Financial Ratios To Understand

3 simple financial ratios to know if a company will continue paying good dividends.

Some companies may choose to pay out a portion of its profits as dividends to its shareholders. Given the low interest rate environment today, companies that pay out good dividends will fall into the radar of yield hungry investors.

Investing For Dividends In Singapore

In Singapore, the benchmark Straits Times Index has an annualised yield of about 3.4% (as of June 2017), this is higher than many regional and even global indexes.

The fact that real estate investment trusts (REITs), which are mandated to pay out 90% of its earnings, are also a major component of the Singapore Exchange (SGX) goes to show that investors in Singapore are extremely keen on dividends. In fact, Singapore’s REIT market is Asia’s second largest, behind Japan.

Dividends are also tax-free in Singapore, which means investors don’t have to pay a single cent of tax on all the dividends they receive from their investments.

Read Also: Supplementary Retirement Scheme – 4 Things You Need To Understand Before Opening An SRS Account

Financial Ratios To Evaluate Companies Paying Good Dividends

When it comes to deciding which companies to invest in for dividend payouts, we shouldn’t simply choose the one that’s paying out the highest returns. You have to remember that receiving high returns also means incurring high risks.

Here are three simple financial ratios to evaluate companies paying out good dividends, and whether they can sustain such dividends. You can also use these ratios to continue monitoring them, and as you gain greater understanding, utilise even more analysis in your research.

#1 Dividend Yield

This is one of the most basic ratios you should know when it comes to dividend investing. The dividend yield is calculated as:

(Dividend Per Share) / (Share Price)

This lets you know how much you are going to receive for each dollar that you invest in the company. Knowing this also lets you benchmark the yield against other assets and investment types such as the STI ETF (close to 3.4% per annum as mentioned above) or even topping up your CPF account (4.0% per annum).

It’s quite obvious that the higher the yield the better it is for investors. However, as mentioned above, higher returns always come with higher risks.

#2 Dividend Payout Ratio

The dividend payout ratio calculates how much of a company’s earnings was paid out as dividends. Hence the formula is:

(Dividend Per Share) / (Earnings Per Share)

Dividend investors usually like companies that pay out as much of its earnings as dividends as possible. This is because they are not looking for good companies who have strong growth potential, and are thus keeping some of its earnings to reinvest into its business.

In fact, dividend investors are looking at the complete opposite type of companies – good companies that do not have strong growth potential (because they’re already industry leaders or very stable companies), and are thus paying out much of it as dividends as they have no better use for the proceeds.

When it comes to dividend investing, the higher the number the better, but there’s no real right or wrong and companies should be compared to what its peers are doing. Just understand that the more of its earnings the company pays out as dividends, the less growth prospects it has and the less reserves it has to withstand shocks to its business.

Read Also: Why Investors Need To Diversify Their Dividend Income, And How They Can Do It

#3 Current Ratio

The current ratio is simply a measure of how liquid a company is. This calculated as:

(Current Assets) / (Current Liabilities)

It basically measures how well the company’s current assets can pay back its current liabilities.

This is one of the most simplistic measure of liquidity, and as you get to understand and research more, you will come into contact with numerous other ratios, some of which are stricter, that you can use as well.

The larger the current ratio of a company, the better it is. Current ratios that amount to over 1 means that the company’s current assets are able to pay it current liabilities. The converse holds true for current ratios that equate to less than 1.

You could also advance to how much free cashflow a company has to pay out dividends at the end of its reporting period.

Read Also: What Your Personality Says About How You Are Likely to Invest

Using Financial Ratios For Your Investment Decisions

When it comes to researching and investing there’s no shortage to the amount of information you can learn. If you try to gain all possible knowledge before investing, you’d find yourself unable to start or paralysed with too much information.

As you dip your feet with limited knowledge, you will slowly but surely build up your understanding and confidence. One good place to start is SGX’s StockFacts portal that allow investors to research companies better.

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