Accounting Ratio

finance a la shmoop what is dividend coverage and what is the dividend payout

ratio? whatever.com has earnings big earnings a hundred million dollars worth

of earnings this year from sales of a whole lot of whatever's the board green [People working in a factory]

lights a dividend payment of 40 million bucks that is the company will pay 10

million dollars to its common shareholders of record four times in

this next year the payout is 40 million because well

you know it's paid out and yeah clever titling know is never a thing on Wall

Street and the payout ratio is 40 over a hundred that hundred million of earnings [Payout ratio calculation appears]

or forty percent well why does the payout ratio even matter?

well companies hate having to cut their dividends and they love raising them if

the former well stock prices usually crash if the latter well they usually go

up and companies love it when their stock prices go up duh so what would [Whatever.com share price rises]

happen if whatever dot-com stumbled in its earnings tumbled and then

shareholders mumbled that the earnings payout ratio had crumbled that is... okay

stop with the rhyming bad timing okay now we're stopping and yeah that is what

if the earnings of whatever.com went down next year to only 50 million

remember they were a hundred million now they're only 50....hmm

problem because now the payout ratio is 80 percent 40 over 50 yeah very

difficult situation the company thought it would have tons of earnings to cover

its dividend at the forty million dollar level more or less forever

but clearly it did not so now what well if earnings recover and go back to a [Man discussing whatever.com's earnings]

hundred million dollars on their way to the 300 million they projected well,

then life is grand no sweat no heavy decisions to be made

but what if earnings fall further to be only thirty million the following year

well then whatever dot-com has to either borrow money or deplete its cash

reserves just to cover its dividend in which case the payout ratio would then

be over a hundred percent meaning that the earnings were 30 million and the [Earnings appear]

dividend was to be forty well then the payout ratio would be 40 over 30

133% ouch can't do that for very long without going bankrupt so payout ratios [Wheel spins and lands on bankrupt]

matter because they give a sense for the safety or certainty that that dividend

will continue at its present rate if the ratio is low well odds are good the

company could certainly afford to raise the dividend over time or at least not

cut it yeah for a very long time ideally and if the ratio is high well your [Dividend cut with scissors]

bottom line may soon be bottoming out back-end load there if i ever saw it...