Dividends, a continuous flow of returns
Passive or conservative investors looking for a stream of income can look to stocks that pay dividends. Dividends are a means of sharing profits in cash with investors. Usually, a company pays dividends on a quarterly basis, or four times a year.
Starbucks’ dividend yields
Starbucks’ dividend yield for 4Q14 was 1.34%. Wall Street analysts estimate this dividend yield to be higher in the first quarter of 2015, or 1.58%. To understand the health of dividend pay-out, dividend coverage ratio comes in handy and is calculated as earnings per share over dividends per share. Starbucks’ dividend coverage ratio was 2.06 in the fourth quarter, which is a good sign as a ratio above 2 is considered healthy. McDonald’s (MCD) had a dividend coverage ratio of 0.65, and Yum! Brands (YUM) had a coverage ratio of 3.7 over the same period.
Understanding dividend coverage ratio
A dividend ratio below 1.5 is usually considered risky and may call for a dividend cut. However, it is not common practice for a company to cut dividends, as it sends a wrong signal to the investment community. A cut indicates that the company’s income is declining or that the company is facing difficult times and needs to retain more of its earnings as opposed to distributing it to investors. During the recession in 2008, 62 companies in the Standard & Poors (or S&P) 500 Index slashed dividends, which, according to Bankrate, was a loss of $41 billion in payouts.
Watch out if the coverage ratio drops below 1
A dividend coverage ratio below 1 indicates that the company is paying its dividend obligations from previous years’ retained earnings. Thus, an investor must look with caution to these changing measurements to assess the health of their dividend-paying stocks. There are many companies that pay dividends. They can be found in exchange-traded funds (or ETFs) such as Consumer Discretionary Select Sector Standard and Poors depositary receipt (or SPDR) fund (XLY), including Darden Restaurants (DRI).
Let’s next look at how investors reacted to the earnings.