The Myth of Dividend Payout Ratio Part II: Is Lower Necessarily Better?

In a previous post I commented how an insistence on low payout ratios can be harmful to investor's returns.

Today, I'll talk about one such example. But instead of showing you an example of a dividend cutter I will show you how a dividend raiser has hurt investors by keeping its payouts artificially low.

Consider CenturyTel (CTL), a telecommunications company and broadband provider. It's a dividend aristocrat, having raised its dividend consecutively for at least the last 25 years. It has raised its dividend by exactly a penny every year since 1999. That equates to about a 4-5% raise per year. Last year, CTL raised its dividends by 519%, including a one-time special dividend, and is on track to deliver a 73% raise this year (without the special dividend, this year's increase would be a whopping 977%).

Sounds impressive, right?

Only until we look at how fast earnings per share (EPS) was growing and how much of it was being paid out yearly. EPS grew at an annualized 6% pace. So far, seems consistent with the 4-5% growth in dividends. However, the payout rate has averaged 10.1% for all years from 1999 until the big dividend raise of 2008. The maximum payout rate during this period stayed below 16%.

This is a rip-off of shareholders money, by my account. Especially considering that during this period, the share price has grown from a low of $35.19 in 1999 to a high of $42 in 2008 -- an annualized 1.9% at best.

While I'm encouraged to see the payout ratio grow to something more significant, I recommend investors investigate the reasons for the sudden change in behavior. Was it due to a policy change? Debt covenants that have since expired? New management? Lack of new investment opportunities -- does the company consider itself mature now?


In general, it's easier to put a price tag on companies with a steadily growing flow of dividends and a stable payout ratio. However, a very low payout ratio needs to be investigated and discounted appropriately, since it's a possible indication that management might not have its dividend policy aligned with that of a serious dividend investor. At the very least, a company that withholds earnings from shareholders needs to have a credible growth plan and a history of shareholder friendliness.

Disclosures: No shares in the above mentioned security at the time of writing.

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