Dividend Per Share (DPS)

What is Dividend Per Share (DPS)?

Dividend Per Share (DPS) is the total amount of dividends a company pays for every ordinary share during a specific period. 

It is an important measure for investors since the amount a company pays out in dividends directly translates to income for the shareholders. 

It is the easiest way for an investor to figure out how much earnings they will get from owning shares of a stock over time.

A constant increase in the ratio over time builds investor confidence resulting in the company's long-term earnings growth. 

Dividend rate: The company's board of directors determines the rate of payouts. A corporation may choose to declare them from its profits or reinvest their earnings within the company. It is entirely up to the board of directors of the corporation.

The best dividend rate per share: The question has no definitive answer because DPS is an absolute quantity, and comparing fundamental values to each other or any benchmark is pointless.

Different companies can have varied compensation plans with vastly varying resources deployed. In other words, comparing DPS for one company to another or a benchmark is not logical.

Higher VS lower ratio rate:

• Some investors prefer a lower rate because they want capital appreciation from their investments. 
• Some investors prefer high rates as they rely on them to pay for their day-to-day expenses. 

Dividend Per Share Formula

It is calculated by dividing all payouts from a company over the number of outstanding ordinary shares issued. A company DPS is commonly used to calculate payouts for the recent quarter, which helps calculate Dividend yield.

The formula is as follows:

DPS = (D - SD) / S

Where

• D: Sum of dividends over a period (Quarter or year) including interim.
• SD: Special, one time.
• S: Shares outstanding.

It is calculated by using the following formula:

DPS = EPS x Dividend payout ratio

Where:

EPS: earnings per share

EPS = (Net income - preferred stock dividends) / outstanding shares

Indications of the formula:

• The increasing ratio over time indicates that the company has sustained earning growth, attracting more investors.
• The decreasing ratio over time indicates that the company has poor earnings and can be a red flag for financial troubles.

Dividend Per Share Example

Suppose ABC has 3 million shares outstanding and paid a total of $237,000 in dividends last year, with a semi-annual payment of $30,000. What is the company dividend per share? 

Annual dividend amount: 

Annual amount = payment x number of payments per year

$30,000 x 2 = $60,000

The DPS of ABC is:

DPS = (dividends - annual dividend amount) / shares outstanding

($237,000 - $60,000) / 3,000,000= $0.059 per share.

Since the question requires us to use semi-annual payments, you should multiply $30,000 by two to get the annual payment. Then, calculate the payout difference between the $237,000 paid out last year and the annual dividends of $60,000. 

The difference that values $177,000 must then be divided by the outstanding shares of 3,000,000 to get the DPS. As you can see above, ABC has a company payout of $0.059 per share.

2. Company ABC has a net income of $7 million. Currently, 9 million shares have been issued, and 4 million are in the treasury. Company ABC wants to examine its payout procedure to restructure the dividend payout rate.

For the past two years, the company has always given out a portion that averages up to 45% of its earnings. So what is the company's dividend per share?

Step-by-step solution to estimate DPS:

Shares Outstanding

Shares outstanding = issued shares - shares in treasury

9,000,000 shares issued - 4,000,000 shares in treasury = 5,000,000 shares

Earning Per Share

Earning per share = Net income/shares outstanding

$7,000,000 / 5,000,000 shares outstanding = $1.4 net income per share

DPS = payout ratio x earning per share

0.50 x $1.4 = $0.7 DPS

Hence, over the past two years, ABC had a company payout of $0.7 per share for each shareholder.

Dividend-paying methods

A company's payout distribution policy determines the number of payouts and the rate they are paid to shareholders.

Each policy has features that differ from others, so companies often select the one that best fits their system.

Investors must be aware of the different types of paying methods. If you want to get consistent payments regardless of market conditions, you are more likely to go with a company with a stable payment method.

However, companies that pay DPS use one of the following policies. 

1. Residual

Companies that use the residual policy prefer to finance new projects with internally generated equity. Therefore, profit payments can only be made from the residual or remaining equity once all project capital requirements are met. 

In other words, after paying for capital expenditures, the corporation pays its portion of earnings to the stockholders. Therefore, the payout rate varies yearly depending on earnings and capital expenditure rates.

Companies with the residual policy are less likely to default since they use their earnings to cover all operating expenses and then continue to pay dividends.

2. Regular 

Under this policy, companies pay their shareholders a yearly dividend at a standard rate in the conditions of either profits or losses. 

If a business generates more money than anticipated, the extra equity will be kept and dispersed to the shareholders as retained earnings. Shareholders will still receive a payment even if the business experiences a loss.

Most companies who prefer this method often have stable earnings and cash flows, so they do not have to worry about meeting their expected earnings. 

They are considered low-risk investments because investors are not given high-profit rates but get paid regularly.

3. Irregular

For this policy, companies have no obligation to give out a portion of their earnings. The board of directors can pay little to no payout to its shareholders if they choose to do so.

Their decision doesn't solely rely on the company's profits or losses. Even if the company's profits increases, it may choose not to distribute payouts.

4. Stable

Companies can pay an annual portion of their earnings regardless of the fluctuations over time. The payout amount is usually calculated by predicting long-term earnings and computing a payout percentage. 

Once the company declares a fixed payout rate based on its prediction, it is obligated to pay the same amount regardless of its profit rate. This policy could be risky for companies since they are responsible for paying stockholders the same rate. 

For example, once the company declares a 9.5% payout. They must be able to pay it whether they gain $1 billion or $1 million.

Under the stable policy, companies may set a goal payout ratio, a percentage of earnings given to shareholders over time, so that investors are ensured it is a low-risk investment. The reason is that they are certain that they can get paid regardless of the company's status.

5. Hybrid

This method combines both residual and stable policies. Companies prefer to employ the hybrid method since businesses undergo business cycle fluctuations. Nonessential product-focused industries are likelier to use this strategy due to their vulnerability to business cycles.

As businesses get worse, they pay a low payout rate. However, they may give investors a better payout rate as the business improves. 

In the eyes of an investor, this type of investment would be risky because it is associated with market conditions that lead to customer uncertainty.

6. No dividend

Companies may decide not to pay at all. Under this policy, all profits are maintained and reinvested in the business to fund expansion potential. Companies that follow this policy tend to grow and expand rapidly.

Types of Dividends

Payouts can be made in a variety of ways, including:

• Cash: The company pays out cash directly deposited in shareholders' bank accounts.

• Stock: The company issues extra shares based on each shareholder's current shares. For example, company ABC announces its stock payout in the ratio of 4:1, which means each investor will receive four bonus shares for each share they hold. In other words, the investor who owns one share will get an additional four shares, while the investor who owns two will receive eight.

• Property: The gain is distributed in the form of (property, plant, and equipment (PP&E)), vehicles, inventory, etc.

• Scrip: The corporation promises stockholders payment at a future date.

• Liquidating:  All of the company's assets are sold, and the money is distributed to shareholders as a dividend only if they first pay off all of the company's debt. Most of the time, liquidating only happens when a company is about to shut down.

The most common form is cash. For example, a company's board of directors decides to pay its stockholders a certain amount in cash on a specific date.

A payment in the form of cash reduces the company's cash flow and assets. It also lowers the shares' market value by the same margin, and the stock price on the market goes down. 

For example, if the price of a share is $45 and a dividend of $5 is paid, the share price will drop to $40 right after the dividend is paid.

The decrease in cash and assets will cause the following:

• First, the liquidity ratio will decrease.
• Second, the debt-to-equity ratio will increase.
• Third, the debt-to-asset ratio will increase.

the Dividend yield ratio

The dividend yield shows how much cash (cash flow) shareholders get relative to the market value per share.

Investors look at this ratio to see how much cash their stock investment is making through dividends or increasing the value of assets through share appreciation.

       Dividend yield ratio = Cash dividend per share / Market value per share

Investors use this formula to calculate the rate of return received on specific investments. More specifically, this formula helps determine how much they receive for every dollar worth of stock.

Remember, comparing the dividend yield ratio of two companies is misleading when checking its performance unless you consider the liquidity method. This is because companies use different policies to distribute share returns among shareholders.

Therefore, if a firm has a higher dividend yield, we cannot claim it is doing better simply because it has a higher yield. However, we can say that the company with a higher total return performs better.

Generally, 2% to 4% is considered reasonable in the stock market, but anything above 4% can be efficient and risky simultaneously. However, it varies from sector to sector. 

Some sectors, like health care, telecommunication, and real estate, have standards for higher dividend yields, while other industries, including consumer discretionary, maintain low dividend yields.

Dividend coverage ratio (DCR)

DCR reflects a company's ability to distribute profits to its shareholders. In other words, it shows how many profit payments a corporation can create from its net income. Therefore, the greater the cover, the less probable the dividend will decline in the upcoming year.

DCR = Net income / dividends declared

Or   

DCR = (Net income - Required preferred dividends) / dividends declared

• A DCR that equals 1 means the company has paid all of the year's earnings. 

• A DCR greater than 1 indicates the company has generated excess profit for the dividend payment. In other words, the company has safe coverage since it enables the corporation to pay earnings while allowing for reinvestment or the risk of a market slump.

• A DCR less than 1 means the company has not generated profits equal to the dividend payment. This indicates a serious situation because the corporation is paying out its reserves, which could be reduced if this continues.

No predetermined payout amount can be described as a satisfactory amount paid out per share. Therefore, it is up to the shareholders to decide whether they would receive dividends or capital appreciation. 

Risky investors prefer capital appreciation since earnings are not realized until the stock is sold. In contrast, risk-averse investors prefer payouts since they know how much they would get out of their stock.

Example:

Company X has $30,000 in dividends, and the profit after taxes is $60,000. What is the dividend coverage ratio of company X?

DCR = Net income / dividends

DCR = $60000 / $30000 = 2

The company coverage ratio, in this case, is greater than 1, which states that the company has made more money than it needs to pay the dividend. So, they have safe coverage, allowing them to pay a portion of their earnings and use the remaining earnings on other operating costs.

The Rationale for Paying a Dividend to Shareholders

Companies tend to follow this method for the following reasons:

1. Show company strength

Constant dividend payments signify that a company is financially sound and that the management has optimistic expectations for future earnings growth.

2. Keep shareholders' loyalty

It allows corporations to share their earnings with their shareholders, rewarding shareholders for their continued support and encouraging them to hold on to the stock.

3. Increase stock prices

A company's stock price increases when it expects to increase its earnings in the future since potential investors are more interested in the business.

4. Build a record of attractive share payout

People who want to make money from stocks are likely to choose companies with a history of giving reasonable rates. This is especially true for retirees, who often depend on regular payments for their lifestyle.

5. Not paying dividends to shareholders

Generally, larger companies are more likely to pay earnings than smaller companies since smaller companies typically reinvest their earnings to enlarge their business's over time.

However, there is no guarantee that a corporation will continue to distribute its profits forever. 

Companies with consistent DPS payments may stop if they are going through an acquisition or another investment that will demand significant cash.

Arguments that support paying dividends

Supporters say that a high payout is significant to investors because it gives investors confidence in the company's well-being. 

Companies that consistently pay their shareholders earnings over the past few decades are usually the most stable. Thus a company that supports this term will attract more investors.

However, an increasing or decreasing payout can negatively affect the company, particularly stock prices. For example, companies with a long history of dividend payments would decline their share prices if they reduced their payments. 

In contrast, corporations that boosted their payouts or implemented a new policy would likely see their stock prices grow.

Criticism

DPS opponents argue that investors would be better off with minimal or no payments. However, supporters of this approach note that it is taxed at a higher rate than capital gains. 

The argument against this approach is based on the notion that a firm that reinvests funds rather than giving them out as a payout will raise the company's long-term value and hence the stock's market value. 

According to the components of this policy, the alternatives to paying out dividends are:

• Handling more projects that align with the market trends. Market demand continually changes based on the customer's financial status. As a result, companies should work on projects that meet customer needs and preferences. 

•  Purchasing the company's shares and reselling them at a higher price. When a company buys back its shares, it reduces the number of shares that can be traded freely, making the shares worth more.

• Acquiring new companies and reinvesting in financial assets. Acquiring companies requires equity and time, but it is a great strategy.

A company can enter new markets internationally through acquisitions, reducing competition, and expanding its customer base.

Researched and authored by Khadega Bazarah | LinkedIn

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