What is Dividend Coverage? Definition of Dividend Coverage, Dividend Coverage Meaning and Concept
Definition of dividend coverage is a ratio that indicates how many times a company can meet the dividend granted, with the net income obtained. It is a financial indicator used both in companies and in financial markets.
Dividend coverage is an indicator that informs about the ability of a company to meet the payment of dividends delivered to investors. Once calculated, it allows you to interpret whether the benefits obtained are sufficient to make said payment.
Below we explain all the data necessary to know this ratio in depth and how to interpret it.
Dividend coverage formula
The formula used to calculate dividend coverage is as follows:
Dividend coverage = net income / dividend
If the result obtained is less than 1, it will mean that the company is paying dividends for a value greater than the benefits obtained.
In the case of being equal to 1, the company will be distributing the total of its profit in the dividends granted.
Finally, if the result is greater than 1, the volume of dividends paid is less than that of the benefits obtained.
Dividend coverage features
Among the characteristics that we can highlight of the dividend coverage ratio are the following:
- It is representative of the sustainability of said dividend in the future.
- Provides useful information for investors.
- Indicates the ability of a company to meet its obligations to investors.
- If it is higher than 1.5, the company has sufficient autonomy to maintain, for the future, the dividend paid.
- A favorable ratio indicates that the dividend of a certain company can be a substitute for a fixed income bond.
Dividend coverage example
Let's suppose that we are part of the board of directors of a multinational company. Our company has obtained in the last fiscal year a net income of 350 million dollars. We decided to reward our investors for their trust with a dividend of $ 230 million.
Under this assumption, the dividend coverage would be calculated as follows:
Dividend coverage = 350/230 = 1.52
By obtaining a result greater than 1, we could affirm that our company, maintaining the same level of net income, is capable and has flexibility to increase the dividend, without the need to assume risks that destabilize it.
In conclusion, dividend coverage is a ratio that shows the ability of a company to meet the dividends paid, with the net income obtained. This being an indicator of the financial type.