The dividend per share, or DPS, is an important financial metric for income investors. It reveals exactly how much passive income can be generated for each share owned in a business. And the DPS can also be used to calculate other critical dividend-related metrics, such as the yield and dividend payout ratio.

Companies often pay dividends to shareholders as a method of returning excess capital. After all, there are only so many worthwhile projects to invest in internally. And many may not be able to create meaningful value. Therefore, if a business generates plenty of cash flow and has no better use for it, dividends or share buybacks are usually issued.

Why is dividend per share important?

Earning dividends from an investment portfolio provides a host of advantages to investors. The list includes:

• Passive Income – Companies that pay a regular dividend can provide a second income stream. This could even grow steadily over time as a firm’s earnings increase supporting a more comfortable lifestyle or retirement.
• Stability – Income stocks are typically less volatile than growth stocks providing desirable stability to an investment portfolio.
• Compounding – Not all investors need access to passive dividend income. As such, this money can be automatically reinvested to buy more shares of the same company. This increases the number of shares they own in the dividend-paying business. That way, the next time dividends are issued, they will receive even more money creating a compounding wealth-building effect.

For this style of investing, knowing the dividend per share is critical. Why? Because it allows income investors to precisely measure their return on investment.

For example, let’s say an investor owns 1,000 shares in ABC Group. The company has just announced a new payment in the coming weeks with a DPS equal to 20p. By multiplying the number of shares owned with the DPS, the investor knows they’ll receive a £200 total dividend payment.

What types of companies pay dividends?

Any firm is entitled to issue dividends to its shareholders at any time. However, shareholder payouts are used solely as a method of returning excess capital to investors. The key word there is “excess”. If a company finds new growth opportunities or wants to pursue value-building projects, dividends will often be de-prioritised.

Younger firms often require a lot of capital to grow and establish themselves within an industry. Therefore, this class of shares usually do not pay any dividends as they need to retain as much capital as possible. That’s why income stocks are typically mature enterprises that don’t deliver much in terms of growth. Of course, there are always exceptions.

Common vs preferred shares

When calculating a firm’s dividend per share, preferred stock must be considered. As a reminder, these are another form of equity, but there are some important key differences.

Preferred shares typically do not carry any voting rights. But they have a high claim to a company’s assets and, in turn, dividends.

Before any payments can be made to common shareholders, preferred stockholders are given priority over dividend payments. That means if there is only enough excess capital to pay dividends to preferred shares, common shares will receive nothing. As such, when calculating DPS, the amount owed to preferred shareholders must be considered.

But why do investors buy common stock if preferred stock has a higher priority claim? Firstly not all companies issue preferred stock. But for the ones that do, the dividends paid to preferred shareholders are fixed. That makes this asset class behave very similarly to bonds.

Consequently, even if earnings improve and the management team announces a higher payout, preferred shareholders will still receive the same amount. Therefore, common stockholders are taking on more risk but have the potential to earn higher returns.

How to calculate the dividend per share?

To calculate a stock’s DPS, an investor needs three pieces of information, all of which can be found in the financial statements and accompanying footnotes.

• Total dividends being paid
• The claim of preferred shareholders (if any)
• The average number of shares outstanding for the period

For example, ABC Group announces a £250m total dividend to shareholders. £50m of this is claimed by preferred stock, with the remaining £200m to be distributed to common stock. The group has 500 million shares outstanding. Therefore the DPS is equal to 40p.

Some investment analysts also modify the DPS formula further to exclude the effects of any special dividends. Why? Because a special dividend is non-repeating and can skew the dividend per share higher than what will be maintained in the future.

Important dividend-related ratios

Beyond indicating how much passive income will be generated, the DPS can also calculate other important financial metrics and ratios.

• Dividend Yield – Compares the dividends per share against the current stock price to determine the percentage return on investment an investor will receive from dividends.
• Earnings Yield – Similar to the Dividend Yield, this metric compares the earnings per share against the current stock price. This represents earnings as a percentage of the share price. And an earnings yield higher than the dividend yield suggests a company can potentially increase its dividend in the future.
• Payout Ratio – Compares the dividends per share against earnings per share. It provides insight into what proportion of profits is being redistributed to investors. This can quickly gauge whether a firm’s dividend is sustainable. A value greater than 100% means a business is paying out more in dividends than it’s making in profits and is usually a strong indicator of a looming dividend cut.
• Retention Ratio – This is the opposite of the payout ratio and represents the capital a company keeps in reserve. A high retention ratio suggests the management team have better use for its money internally, potentially leading to more long-term growth.

This metric can also be used in more advanced corporate valuation calculations, such as a dividend discount model – a discounted cash flow model variant.

The bottom line

The dividend per share can be a powerful financial metric that helps investors make more informed decisions. With the right adjustments, building a lucrative stream of passive income with income stocks is possible, leading to a more comfortable retirement.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.