Dividend Cover: What to Look For Before You Chase a Yield
A high dividend yield is sometimes a reward and sometimes a warning. Cover tells you which.
A yield of twelve percent looks like an opportunity. It is just as often the market telling you the dividend is unlikely to be paid again at that level.
What cover measures
Dividend cover is the ratio of earnings to dividends paid. Cover of two means the company earned twice what it distributed. Cover below one means it distributed more than it earned, funding the difference from reserves or borrowing.
Sustained cover below one is not a dividend. It is a partial return of your own capital, dressed as income.
Beyond the headline ratio
- Check cover on cash flow, not only on accounting earnings — earnings can be managed, cash is harder to fake
- Look at the trend across several years rather than a single snapshot
- Understand whether earnings are cyclical, because cover at the top of a cycle flatters badly
- Read what management has actually committed to on future distributions
A moderate yield with strong, stable cover will usually serve an income investor better than a headline yield that halves next year — and it will do so without the capital loss that typically accompanies the cut.
Topics
- NSE
- Dividends
- Risk
Written by
Brian Mutiso
Senior Equity Analyst
- CFA Level III Candidate
- BSc Actuarial Science
This article is general information, not personalised investment advice. Please speak to an adviser about your own circumstances before acting on it.
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