Why Dividend Payout Ratios Aren’t Always What They Seem

I owned Capital Power Corp. CPX for several years. With a current dividend yield of over 5% and steady capital growth, it’s been a good fit for my dividend portfolio so far. But he has an extraordinarily high payout ratio of 543%. Does it make sense to hold it expecting the dividend to be sustainable?

I’ve said it before and I’ll say it again: if you’re trying to determine a company’s dividend sustainability, don’t rely on payout ratios published on financial websites. These are usually computer-generated numbers that provide no context or information on how they were calculated. As a result, they often paint a misleading picture of a company’s ability to sustain its dividend.

Capital Power is a good example. I’ve seen the same inflated payout ratio figure on several different websites; it appears to have been calculated by dividing the company’s total dividend of $2.12 over the past 12 months by its 2021 earnings per share of 39 cents.

There are a few issues with calculating Capital Power’s payout ratio this way. First, due to one-time factors, revenues often vary greatly from year to year. Adjusted for unusual items such as impairment charges, foreign exchange gains or losses, and changes in the fair value of assets, Capital Power’s “normalized earnings per share” was $1.97 in 2021 Using that higher earnings figure, the payout ratio was a less glaring 108 percent.

That’s still uncomfortably high, which leads to the second problem with how some websites calculate payout ratios: they often use inappropriate metrics. With independent power producers such as Capital Power, profits are often depressed by accounting charges such as depreciation that do not affect the company’s cash flow or its ability to pay dividends. For this reason, analysts sometimes base the payout ratio on a company’s free cash flow instead of its book earnings.

In 2021, Capital Power’s adjusted funds from operations, or AFFO — a cash flow measure included in its income statements — was $5.40 per share. Dividing the company’s annual dividend per share by its AFFO per share yields a payout ratio of just under 40%. This is much better than 543%. It is also well below Capital Power’s target payout ratio, which is between 45% and 55%.

Thus, the company’s dividend appears to be very sustainable indeed. Additionally, Capital Power has been increasing its dividend for many years and expects annual increases of around 5% through 2025. The company discussed this at its Investor Day in December; you can find a copy of the presentation in the investor relations section of its website.

Bottom Line: With payout ratios, the numbers published on financial websites can sometimes mislead you. In many cases, you need to review company financial statements and earnings presentations — and consult analyst reports if you have access to them — to determine whether a company’s dividend is safe.

Does withholding tax apply to U.S. dollar dividends paid by Canadian corporations such as Brookfield Asset Management Inc. BAM.A and Nutrien Ltd. RNT? Also, is it possible to easily direct US dollar dividends to a separate US dollar account with major banking institutions in Canada to avoid currency conversion fees? We would like to use our US dollars to travel.

Dividends paid in U.S. dollars by U.S.-based corporations are generally subject to withholding tax, except when the shares are held in a registered retirement savings plan, registered retirement income fund, or other account that specifically provides retirement income. Tax-Free Savings Accounts and Registered Education Savings Plans are not eligible for this exemption.

However, if a Canadian corporation declares dividends in US dollars – as many do – US withholding tax does not apply. This is true whether the shares are held in a non-registered account, an RRSP, RRIF, TFSA or any other registered account. In addition, US dollar dividends declared by Canadian corporations are generally still eligible for the dividend tax credit. You can confirm this by reading the company’s latest dividend announcement or by visiting the dividends section of its website.

So, no, you don’t have to worry about US dividend withholding tax on the Canadian stocks you mentioned.

As for avoiding currency conversion fees, that should be relatively simple. Generally, for Canadian companies such as Brookfield and Nutrien that are listed on both a Canadian exchange and a US exchange, you can choose to hold the shares on the Canadian or US side of your brokerage account to match the currency. in which you wish to receive the dividends. To withdraw US dollars, you will likely need to open a US dollar bank account to receive the transfer. Check with your broker for the options available to withdraw US funds without converting them to Canadian currency.

Email your questions to [email protected]. I am unable to respond to emails personally but I choose certain questions to answer in my column.

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