Skip to main content
investor clinic

Your recent article regarding Capital Power Corp. (CPX-T) stated that the dividend payout ratio is between 45 per cent and 55 per cent, yet my discount broker and Globe Investor both indicate the ratio is between 195 per cent and 205 per cent. Am I missing something?

There are different ways to calculate a company’s payout ratio. Doing it the wrong way can make a dividend look unsustainable when it’s actually quite safe.

Capital Power is a great example. In my column, I wrote that the power producer “expects its payout ratio will remain below its long-term target range of 45 per cent to 55 per cent of AFFO – a conservative cash-flow measure – giving the dividend plenty of protection.”

The key word to focus on here is AFFO, or adjusted funds from operations. AFFO represents the net cash available from operating activities after adjusting for maintenance capital expenditures, preferred share dividends and other items. Essentially, AFFO measures the net cash available to fund the company’s growth, repay debt and pay common share dividends.

Based on this measure, Capital Power’s dividend is indeed very secure, which is why the company is projecting the dividend will continue to grow at about 6 per cent annually through 2025.

However, you wouldn’t know that based on the bloated dividend payout ratio published by discount brokers and financial websites. These payout ratios are typically calculated as a percentage of earnings, not AFFO. This can paint a misleading picture, because earnings of power producers (and some other companies) are often depressed by accounting items such as depreciation that don’t affect the company’s cash flow or its ability to pay dividends.

The result is that some companies appear to be paying out way more than they can afford. I often hear from readers who fear a dividend cut is imminent based on a seemingly egregious earnings payout ratio, when there is actually no risk at all.

As I’ve said many times, please don’t rely on the payout ratios published by third-party websites. These are machine-generated numbers that lack important context. They may be correct in some cases, but very misleading in others. You’re better off going directly to the company’s website and reading its financial reports and investor presentations to learn about its payout ratio and the sustainability of its dividend.

I own American depositary shares of GSK PLC (GSK-N). According to my June 30 statement, I held 2,700 GSK shares with an adjusted cost base (ACB) of US$40.34 and a market value of US$43.53. However, my July 31 statement says I now own only 2,160 GSK shares with an ACB of US$50.42 and a market value of US$42.17, in addition to 2,700 new shares of Haleon PLC with an ACB of US$7.45 and market value of US$7.03. Now I have a loss on paper for my GSK shares. What’s going on here?

In July, British pharmaceutical company GSK PLC spun out its consumer health care business – maker of Advil, Sensodyne, Centrum, Tums and other brands – as a separate publicly traded company called Haleon PLC (HLN-N). Investors received one Haleon share for each GSK share held.

All else being equal, spinning out the value of Haleon would have caused GSK’s share price to drop substantially. To avoid that – and to make its share price and earnings per share roughly comparable with previous periods – GSK decided to consolidate its shares on a four-for-five basis, meaning the number of shares would decrease but each share would be worth more. That’s why you now own four-fifths as many GSK shares but the share price as of July 31 was similar to the price on June 30.

As for the ACB of your GSK shares, this is where things get more interesting. In a supplementary document, GSK stated that investors should allocate the aggregate cost of their original GSK depositary shares across their new GSK and Haleon shares in proportion to the relative market value of each. The company provided a sample calculation showing that, based on July 18 closing prices of GSK and Haleon on the London Stock Exchange, 81.84 per cent of the original ACB should be allocated to the GSK shares, with the remaining 18.16 per cent allocated to the Haleon shares.

However, I suspect your broker did not follow this method. If you multiply your original cost base of US$40.34 per share by 2,700 GSK shares, your total cost works out to US$108,918. But if you multiply the new ACB (provided by your broker) of US$50.42 by your current 2,160 GSK shares, you get a very similar number of US$108,907. I don’t see how that can be right, because a chunk of your total ACB should have been allocated to Haleon.

I suggest you read the GSK document and discuss any concerns with your broker or a tax professional. Finally, keep in mind that adjustments to the ACB don’t affect the value of an investment. They only affect the size of the capital gain or loss that will ultimately be reported for tax purposes. A higher ACB – even if it may not be correct in this case – is generally a good thing, because it means lower taxes down the road.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.