Dividend to Earning Ratio and Dividend Growth

Dividend to Earning Ratio and Dividend Growth

High dividend to earnings ratio negatively impacts the dividend future growth. This is because funds are not reinvested for earn profit in future, rather it is paid. This concept can be explained by following example

Dividend to earnings Ratio = (Dividend)

                             (Earning)

Divided to earnings Ratio example

A company has paid divided 5 million & 10 million during the year 2001 & 2002 respectively. The earning of the company was 20 million each year. the rate of investment is 15%.

Solution

1.    10 million Dividend payment

= Dividend/earning

= 5million/20 million

= 25%

Dividend Growth = 75% x 15%

=11.25% (Dividend Growth)

2.    5 million dividend payment

= Dividend/earning

= 10 million/20 million

= 50%

Dividend Growth = 50% x 15%

=7.5% (Dividend Growth)

Above example shows that with high dividend to earnings ratio, you will achieve low growth rate, while in case of low dividend to earnings ratio, you will achieve high dividend growth.

Dividend to Earning Ratio

Dividend to Earning Ratio

Dividend to earning ration can be express by simple formula. It is important remember that high ratio reflect that high amount is paid to the shareholder, where low ratio reflect the low payout to the equity holder.

Dividend to earnings Ratio = (Dividend)

                             (Earning)

Divided to earnings Ratio example

A company has paid divided 10 million & 15 million during the year 2001 & 2002 respectively. The earning of the company was 25 million each year.

Solution

1.    10 million Dividend payment

= Dividend/earning

= million/25 million

= 40%

2.    15 million dividend payment

= Dividend/earning

= million/25 million

= 60%

Above answer clearly shows that high dividend to earnings ratio means that you are distributing most of profit to equity holders.

Dividend Growth and Rate of Investment

 Dividend Growth and Rate of Investment

Dividend Growth and rate of investment relationship was explained by the Gordon by a formula i.e. Growth = Retention x rate of investment. It suggests that with higher rate of investment, we can expect higher growth in future. This relationship has been explained with below example,

 Dividend Growth and Rate of investment Example

F & Co rate of investment for 2001 & 2002 is 5% and 8% respectively. F & Co has consistent policy to retain 50% of its earning. Calculate the divided for both years?

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

1.    Rate of investment 5%

= 50% x 5%

=2.5%

1.    Rate of investment 8%

= 50% x 8%

=4%

The above results clearly that rate of investment the growth rate increases.

Dividend Retention and Dividend Growth

Dividend Retention and Dividend Growth

Dividend retention and dividend Growth relationship was explained by the Gordon by a formula i.e. Growth = Retention x rate of investment. it means that with more retention of dividend , growth of dividend may be accelerated. This has been explained with an example,

Dividend Retention and Dividend Growth Example

B has profitable operation and is interested in future growth of dividend. The cost of investment of C & Co is 13%. There are two suggestions that to retain 40% and 60% of its income, which option should be chosen for higher growth rate of dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

1.     Dividend Retention 40%

= 40% x 13%

=5.2%

2.    Dividend Growth 60%

= 60% x 13%

=7.8%

Above results clearly shows that growth of dividend increases by retaining more earning.

Gordon Growth Payout Example

Gordon Growth Payout Example

C Company is making huge profit and board of director has decided to pay 70% of its earning. The cost of investment of C & Co is 11%. Calculate the Gordon Growth of Dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

In this example we are not given dividend retained %, therefore in first place we would calculate the Dividend retained from dividend payout % i.e. (Divided retained = 1- Dividend paid).

1.    Retained Divided

Dividend Retained = (1- Dividend paid)

Dividend Retained = (1- 70%)

Dividend Retained = 30%

2.    Dividend Growth

= 30% x 11%

=3.3%

Gordon Growth Dividend Model Example

Gordon Growth Dividend Model Example

XYZ Company board of director has planned to retain 70% of earning. The cost of equity in the market is 16%. Calculate the Gordon Growth of Dividend.

Solution

Gordon Growth of Dividend = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

By putting value in above formula, we can solve the above Example

= 70% x 16%

=11.2%

Gordon Dividend Growth Model Example

Gordon Dividend Growth Model Example

ABC Company director decide to retain 60% of earning. The cost of equity is 15% in the market. Calculate the Gordon Dividend Growth for ABC Co.

Solution

Gordon Dividend Growth formula = Retained Earning x Return, this formula can be expressed

G=Br

Where,

G= Dividend Growth Rate

B= Retained earning

r= Rate of return on equity

By putting value in above formula, we can solve the above Example

= 60% x 15%

= 9%