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Dividend        yield and Dividend payback

Dividend yield and dividend payback are two sides of the same coin

By Altaf Noor Ali, ACA
Aug  20 - 26 , 2001

'Dividend yield' is an important piece of stock analysis, refered by investors and analysts alike, and is therefore quoted frequently in business press. The dividend yield figure requires 'updating' on daily basis for active scrips, to reflect changes in the closing price.

The importance of 'dividend yield' is that it relates the latest available data of dividend per share to the closing price of a listed stock. It can be expressed as a ratio or in terms of percentage.

As an example, we will use the figures relating to Fauji Fertilizer Company Limited as follows

 

Reference

2000

1999

Dividend per share (Rs )

1

8

8

Price per share (Rs.)

2

40

50

Dividend yield ratio

3=1/2

0.20

0.16

Dividend yield (%)

.

20%

16%

The dividend yield (%) serves a useful purpose. It provides a benchmark in evaluating alternative options for investments. For example, any investor will find the above yields to be competitive when comparing it with other scrips or evaluating schemes offered by commercial banks.

Dividend payback:

In addition to dividend yield, would users of financial information benefit from knowing how long it will take, in terms of a time frame, to recover the amount invested at the going closing rates?

The financial yardstick used to measure this data is called 'dividend payback'. It expresses the number of years in which the dividends paid to the shareholders will equal the price of investment, assuming that the company continues to maintain the latest level of dividends in the forseeable future.

Simply put, to find out dividend payback, the price of a stock is treated as a 'cash outflow' and 'dividends' as 'cash inflow'. The payback is computed by taking cash outflow (price per share) and dividing it by cash inflow (dividend per share). In other words, dividend payback is a point where dividends equal price, in absolute terms.

The stunning aspect of 'dividend payback' is that it requires no more information than what is required for 'dividend yield'. In fact this piece of information comes embedded in dividend yield figure.

In case of Fauji Fertilizer, it will be computed as follows

 

Reference

2000

1999

Dividend per share (Rs)

1

8

8

Price per share (Rs.)

2

40

50

Dividend payback (years)

3=2/1

5

6.25

Putting it all together:

Dividend yield serves as a basic benchmark for comparing yields from various options of investments. It relates dividend to the stock price, and expresses the result in the form of a ratio or percentage.

The information used for finding 'dividend yield' can be used to compute 'dividend payback'.

In a pyramid form the above relationship can be stated as follows:

1
Dividend payback Dividend yield

The above means that dividend payback= 1 by dividend yield.

In other words, dividend payback is the reverse of dividend yield. The dividend payback can be computed simply by taking the number one and dividing it by dividend yield.

In case of Fauji Fertilizer Company Limited, the dividend payback will be computed as follows:

 

2000

1999

Dividend yield (%)

20%

16%

Dividend yield ratio

0.20

0.16

Dividend payback (years)

5*

6.25

* Unity (i.e the number 1) divided by yield ratio, 1 by 0.20. Note that time value of money is ignored in computation of payback.

Practical application:

We will now compute 'dividend yield' and 'dividend payback' for some popular stocks listed on Karachi Stock Exchange, using closing rate quoted in newspapers on 31 July 2001. The dividend data is on 'per share' basis based on latest year ended.

Scrip

1

2

3=1*2

4=2/1

 

Close
Rs.

Dividend
Rs.

Payback
(years)

Yield
(%)

Shell Pak

218.95

16.50

13.26

7.54

PSO

124.10

10.00

12.41

8.06

Adamjee Insurance

41.25

3.00*

13.75

7.27

EFU General Insurance

27

3.583*

7.54

13.27

Fauji Fertilizer

34.65

8.00

4.33

23.09

Engro Chemicals

51.05

8.50*

6.00

16.65

Lever Brothers

730

46.40**

15.73***

6.36

Notes to the Table:

*Normally only cash dividend is taken for computing dividend yield. However in our opinion, stock dividend is also an indirect distribution of cash to shareholders. For correct analysis, stock dividend is added to the cash dividend for computing 'yield'.

For Adamjee, the distribution was 15% cash and 15% stock. For EFU General it was 22.50% cash and 13.33% stock. Similarly for Engro Chemicals, the distribution was 70% cash and 15% stock.

**The actual distribution is 232% cash. However, the face value of each share of Lever Brothers is Rs. 50 and the dividends have been adjusted accordingly.

***The figures for 'yield' and 'payout' can be validated easily. Multiply dividend yield by dividend payback and the result must be equal to one approx. The higher the yield the lower will be the payback.

In above computations, we have assumed no deduction of withholding tax, whereas according to Pakistan laws withholding tax is deducted from the gross dividend, depending on the status of the payee. For individual shareholder, the rate of withholding tax is 10%. Proper adjustments therefore should to be made in the above figures for individual application.

Conclusion:

Dividend yield and dividend payback are two sides of the same coin. They provide two different angles of looking at the same information. The use of these ratios in pairs can be helpful in enhancing the understanding of financial data.