ShmoopTube

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

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

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

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

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million dollars to its common shareholders of record four times in

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this next year the payout is 40 million because well

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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