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Declaring and paying dividends has nothing directly to do with current earnings per share (EPS). Companies can pay a dividend per share that exceeds its EPS. A company whose EPS is lower than its dividend in a current year may be coming off of a string of more profitable years, with higher EPS, from which it has set aside cash to pay future dividends.
Key Takeaways
- Companies can pay dividends that exceed earnings per share (EPS), using cash set aside from previous years to pay dividends.
- When considering dividends, the major numbers that matter is cash and retained earnings—EPS, less so.
- Many well-known Fortune 500 companies have paid dividends in years where they posted negative EPS.
- Having a large retained earnings balance allows a company to pay consistent dividends with no negative surprises.
- EPS is calculated after higher-yielding preferred stock dividends have been paid, where a large portion of a company’s dividend costs may already be reflected in EPS.
Many well-known Fortune 500 companies have paid dividends in years where they posted negative earnings per share. The only numbers that matter in paying dividends are retained earnings and available cash.
Dividend Payout Ratio
In the case that EPS is used to assess a company’s ability to pay dividends, the dividend payout ratio is used. The dividend payout ratio is the dividend per share divided by EPS.
A dividend payout ratio of less than 100% means that a company is paying out less than 100% of its earnings via dividends to shareholders.
From a management point of view, retaining some of the shareholders‘ earnings quarterly or yearly makes a lot of sense. Having a large retained earnings balance allows a company to pay consistent dividends with no negative surprises. In addition, the company can keep cash on hand to reinvest in its future expansion.
On a related note, many investors do not realize that a company’s EPS is calculated after the higher-yielding preferred stock dividends have been paid. In other words, a large portion of a company’s dividend costs already may be reflected in the EPS number that most investors look at.
Companies With High Payout Ratios
Many times real estate investment trusts (REITs) and master limited partnerships (MLPs) will pay out dividends that are greater than their earnings. This comes as REITs and MLPs must pay out over 90% of income via dividends. Thus, it’s easier for their dividends to exceed earnings in certain periods.
For example, Extra Space Storage (EXR) has a payout ratio of 172.8%, while Mid-America Apartment Communities (MAA) has a payout ratio of 137%.
What’s the Difference Between Dividend Yield and Dividend Payout Ratio?
Dividend yield and payout ratio are both metrics that are commonly used to compare the dividends that a company returns to its shareholders. The difference is that the dividend yield shows the amount of dividends as a percentage of the company’s share price. The payout ratio compares the dividend to a company’s earnings per share.
What Does a High Payout Ratio Mean?
A high payout ratio means that a company returns a relatively large share of its earnings to shareholders in the form of dividends. This is particularly common for real estate investment trusts, which are required to return 90% of their taxable earnings to shareholders.
What Does It Mean If a Company Has a Low Payout Ratio?
A low payout ratio means that a company returns a relatively low share of its earnings to shareholders as dividends. This is not necessarily a bad thing: Some companies prefer to reinvest their earnings for future growth. Others may choose to execute stock buybacks, which has the effect of raising the share price without incurring a taxable event for shareholders.
The Bottom Line
While most companies only give a fraction of their earnings to shareholders as dividends, it is not uncommon for a company’s dividend to exceed its earnings per share. If a company experiences short-term losses, it may still be preferable to keep a stable dividend than signal financial insecurity. In the long term, a company’s dividends are limited by its ability to make a profit.
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