Discover how dividend coverage ratios are calculated for preference, equity, and fixed-interest shares to assess payout sustainability.
Dividend coverage ratios show how easily a company can pay dividends from its earnings. They vary across preference, equity, and fixed-interest shares. These ratios provide insight into dividend sustainability and financial stability.
The Preference Dividend Coverage Ratio (PDCR) evaluates how many times a company’s net profit covers its fixed dividend obligations to preference shareholders.
Since preferred dividends are fixed and must be paid before any equity dividends, this ratio serves as an indicator for assessing income stability.
A higher ratio indicates a greater degree of coverage.
Here’s how to calculate the preference dividend coverage ratio using a simple formula:
Formula:
Preference Dividend Coverage Ratio = Net Profit After Tax ÷ Preference Dividend Payable
A company earns ₹50 lakh in profit after tax and owes ₹10 lakh in preference dividends.
PDCR = 50 ÷ 10 = 5
This means the company earns five times what is required to pay its preference shares—signaling adequate coverage.
Here’s what different preference dividend coverage ratio levels reveal about a company’s payout capacity:
| Ratio Range | Interpretation |
|---|---|
≥ 2 |
Indicates that profits sufficiently cover dividend payouts. |
1 – 2 |
Moderate coverage; monitor earnings stability. |
< 1 |
Insufficient; company may struggle to meet dividend commitments. |
Key Insight:
A PDCR below 1 indicates the company is not generating enough profit to fully cover its preference dividends, which could signal financial stress or unstable cash flows.
The overall dividend coverage ratio shows how well a company’s net income can cover total dividends (both preference and equity). It provides a broader view of dividend sustainability.
Formula:
Overall Dividend Coverage Ratio = Net Income ÷ Total Dividends Declared
Benchmark:
A ratio above 2 typically suggests adequate coverage, while a ratio below 1.5 may indicate weaker payout capacity.
The Equity Dividend Coverage Ratio (EDCR) measures how comfortably a company can pay dividends to ordinary shareholders after fulfilling preference obligations.
Formula:
Equity Dividend Coverage Ratio = (Net Profit – Preference Dividend) ÷ Equity Dividend
Interpretation:
High ratio (≥ 3): Strong earnings, stable equity dividend payout.
Low ratio (< 1.5): This may indicate that dividend payments depend on reserves or borrowings.
For firms paying both debt interest and preference dividends, the Interest & Fixed Dividend Coverage Ratio provides a combined perspective on coverage of all fixed obligations.
Formula:
(Net Profit + Interest Expense) ÷ (Interest Expense + Preference Dividend)
This ratio is important for companies with mixed capital structures, offering a full picture of profit adequacy before equity returns are considered, alongside indicators like the put call ratio.
While dividend coverage ratios offer clear insights, they must be interpreted carefully:
Earnings volatility: Seasonal or cyclical businesses show fluctuating ratios.
Accounting adjustments: Non-cash expenses (like depreciation) can distort profit figures.
Industry norms: Utilities and FMCG firms maintain high coverage; startups or cyclicals may operate lower.
Dividend policy changes: One-time dividend decisions may temporarily inflate or depress ratios.
Thus, analysts should review coverage trends over multiple periods, not just one fiscal year.
Study the following illustration:
Company A Ltd. reports:
Net Profit After Tax: ₹60 lakh
Interest Expense: ₹10 lakh
Preference Dividend: ₹5 lakh
Equity Dividend: ₹15 lakh
Preference Dividend Coverage Ratio:
60 ÷ 5 = 12 times
Equity Dividend Coverage Ratio:
(60 – 5) ÷ 15 = 3.67 times
Interest & Fixed Dividend Coverage Ratio:
(60 + 10) ÷ (10 + 5) = 4.67 times
Interpretation:
Company A’s profits adequately cover all dividend and interest obligations, reflecting stable financial position.
Dividend coverage ratios are vital for assessing how comfortably a company can sustain its dividend payments. They provide insight into earnings strength, payout safety, and long-term shareholder reliability.
Key takeaways:
Dividend coverage ratios gauge a company’s capacity to pay dividends from profits.
Preference coverage focuses on fixed priority dividends, while equity coverage looks at residual payouts.
A combined (fixed-interest) ratio helps evaluate all mandatory commitments.
Higher ratios reflect greater profit coverage of dividends.
Always compare ratios against industry benchmarks and historical trends for accurate evaluation.
Indicative Benchmarks:
Preference Coverage ≥ 2
Equity Coverage ≥ 3
Overall Dividend Coverage ≥ 2
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The Preference Dividend Coverage Ratio is calculated by dividing Net Profit After Tax by Total Preference Dividends Payable. The result indicates how many times a company’s profits can cover its fixed dividend commitments to preference shareholders, reflecting dividend security.
Preference Dividend Coverage measures a company’s ability to meet fixed dividend obligations to preference shareholders, whereas Equity Dividend Coverage evaluates the sustainability of dividends paid to ordinary shareholders. The former focuses on fixed returns, while the latter assesses residual income distribution.
The Fixed Dividend Coverage Ratio extends the concept of Interest Coverage by including both interest and preference dividend payments. It helps determine whether total profits are sufficient to meet all fixed financial obligations comfortably, ensuring financial stability and investor confidence.