Dividend cover

Understanding dividend cover is crucial for anyone considering investing in stocks on the Nigerian Exchange (NGX). Essentially, this metric tells you how many times a company’s earnings per share (EPS) can cover its dividend per share. Imagine you own a popular local restaurant that makes a steady profit. If you decide to give out a significant portion of that profit as dividends to your investors, you need to ensure you’re not spending more than you earn. If your restaurant’s earnings are twice what you give out as dividends, your earnings are comfortably covering the dividends. This scenario is ideal because it leaves a buffer for unexpected expenses or downturns in business.

In Nigeria, many companies listed on the NGX pay dividends to their shareholders. For instance, if a company’s EPS is ₦5 and it pays a dividend of ₦2 per share, the dividend cover ratio is 2.5 (₦5 ÷ ₦2). This indicates that the company’s earnings are more than sufficient to cover its dividend payments. However, if the EPS drops to ₦1.5 while the dividend remains at ₦2, the cover ratio falls to 0.75. This means the company is paying out more than it earns, which could lead to a reduction in dividends if the situation persists.

A dividend cover ratio below 1.2× is a red flag. Suppose you run a small business like a popular tailoring shop in Lagos, and you’ve been consistently paying out a portion of your earnings to your investors. If suddenly your profits drop due to unforeseen circumstances, like an economic downturn or increased competition, and your earnings fall below the amount you pay out as dividends, you would have to either borrow money or cut back on dividends. This can be risky and may affect investor confidence.

In the Nigerian context, some investors may also be concerned about the 10% withholding tax (WHT) on dividends and the 10% capital gains tax (CGT) when selling shares. These taxes can reduce the net amount of money you receive from your investments. Therefore, understanding dividend cover helps you assess whether a company can sustain its dividend payments over time, even when considering these taxes.

Why it matters: Knowing the dividend cover ratio helps you make informed decisions about your investments. A company with a solid dividend cover ratio is more likely to maintain its dividend payments, providing a steady income stream. This stability is particularly important in a volatile market like Nigeria’s, where economic conditions can change rapidly. By choosing companies with strong dividend cover ratios, you can better safeguard your investment against market fluctuations and company-specific risks.