The Secret Formula – Dividend Payout Ratio

J/k there really is no secret formula but it sure makes for a more interesting headline (Click bait anyone?). So, how do you calculate the dividend payout ratio of a company? Easy, Take the current dividend payout and divide it by the current earnings per share. This will give you the Dividend Payout Ratio.

Dividend per share/Earnings per share = Dividend Payout Ratio

This should be fairly obvious for most people. But I will try to make this as clear as possible, if a company has a dividend payout ratio of over 100% and is paying out more than it earns – this is NOT a good thing.

In most cases a company can not sustain a dividend payout ratio of more than 100%. This simply is not sustainable. A dividend cut is almost certain and it’s likely that you will see a large drop in share price. This means a good portion of your investment is about to disappear as fast as a joint at a Bob Marley concert.

Today a friend of mine had mentioned that AGF.B (Canadian mutual fund manager) had a fairly juicy dividend yield close to 7%. I thought good enough, I wonder what the payout ratio is? Was the history of the dividend payment solid? Ultimately is AGF.B a dividend trap? Is this a good investment?

So without further ado, let’s take a look at AGF.B and see if we can get a few answers to these questions.

Let’s start with a chart that illustrates the dividend history of AGF.B since inception. You can clearly see that AGF.B has had a fairly steady payout ratio and a good history of dividend payment increases. This is good. And then a giant dividend cut in 2015. This is bad.

There was also a small glitch in 2008, I did a quick google search but couldn’t turn up any specific reason. I would have to guess that AGF was just participating in the general doom and gloom of the GFC of 07/08.

agf.b-dividend1

So why the giant dividend cut at the beginning of 2015? Simple, it’s all about earnings and payout ratio. If AGF.B were to continuing paying out their dividend of $0.27 a share, it would be paying out roughly 154% of 2014 earnings. This is not sustainable. The effective dividend yield passing 10% and ending 2014 at 14.73%, should have given a clear indication to investors that a dividend cut was most likely going to happen, followed by a large drop in share price.

AGF.B Dividend Payout 2014 – $0.27 X4 / 0.70 = 154%
AGF.B Dividend Payout 2015 – $0.08 X4 / 0.61 = 52% – Payout Ratio

agf.b-anual-dividends

So after a consistent period of having a dividend payout ratio over 100%. AGF.B slashed their dividend in January – 70% from $0.27 per share to $0.08 per share. Their share price dropped 21% the day the dividend was cut. The share price is down over 40% YTD and it looks even worse when you look at the 5yr and 10 yr chart.

vertical-drop

It’s quite possible that the riders of this slingshot would have received a bigger thrill from the vertical drop of AGF shares over the last 10 years.

The bottom line is the AGF.B’s financials could not support a dividend payout ratio of 300+% at a time when its financial outlook was weak.

So despite the bad news of a dividend cut, the management team at AGF decided that a portion of the newly available cash would be put towards share buy backs which would strengthen the position of the remaining shareholders and potentially increase earnings per share.

“If we assume that approximately 70% of the additional available cash will be used to repurchase shares at an average price of $8, AGF management will be able to repurchase [roughly] 3.70 million shares under the program,” he said in a note to clients. “In our opinion, this would be immediately accretive to EPS by 4.5%.*”

Just like Bombardier, Rogers, Google and countless other companies AGF has a dual class share structure. The Goldring family controls AGF through special class “A” stock that the general public can’t own – this means that they have the ultimate say in what happens to AGF. Shareholders have little to no rights in governing the company.

So is AGF a good investment?

There really is no simple answer. Right before the GFC, AGF stock was trading at around $38 per share. This would have given AGF a market value of 3.4 Billion. Today in comparison AGF has a market value of $413 Million. Considering current market cap and the dividend cut and the obvious fact that the mutual fund business is slowly becoming obsolete – I’m going to go ahead and call this a classic case of “Bad Timing” with a side dish of “Bad management”.

Hind sight is 20/20 but it looks like AGF missed their big opportunity when the likes of CI financial and the banks were on an acquisition spree in the mid/late 00’s.** We are now ushering in the new era of financial management which include low cost ETFs, Robo advisors and direct online investing. I hope that AGF can adapt to these new technologies and embrace the future but at this point things don’t look to good for AGF.B. At this time I would say that there are better opportunities out there for both yield and potential growth. But I most certainly could be wrong.

Dividend investing is popular and the idea of collecting a regular cash payment from your investments is why capitalism is great. But simply throwing money into stocks with high yields is rarely a good idea and most likely could cost you your entire investment if not careful.

There are many different criteria to consider when making a decision to purchase an individual stock and Dividend payout ratio should be examined to make sure an investment is a smart one.

*Financial Post – AGF’s Share buy back plan
**Scotia acquisition of DundeeWealth for $2.3 billion

Author: The Money Runner

Husband, father, runner, personal finance enthusiast and computer geek. Thanks for visiting. Please check out my other posts and follow me on Twitter and Facebook.

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