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.
- 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, here are some of the current MLPs or REITs with payout ratios of above 100%. Extra Space Storage (EXR) has a payout ratio of 108%, while Mid-America Apartment Communities (MAA) has a payout ratio of 137%. Then there’s ONEOK (OKE), which has a 186% payout ratio.
However, even major mega-cap companies can have dividends that exceed earnings. For example, there’s Procter & Gamble (PG). P&G has a payout ratio of 163%. That is, its current annual dividend is right at $3.00. However, its EPS over the last twelve months has been a mere $1.84. The company has been using its cash hoard to fund its dividend as earnings have been down.