Dividend Payout Ratio

Dividend Payout Ratio compares the dividends paid by a company to its earnings. The part of the earnings not paid to investors is left for investment to provide for future earnings growth.

Dividend Payout Ratio

Dividend Payout Ratio compares the dividends paid by a company to its earnings. The part of the earnings not paid to investors is left for investment to provide for future earnings growth. Companies with a low Dividend Payout Ratio attract investors looking for long term capital growth. Investors interested in short term earnings tend to prefer companies with high Dividend Payout Ratio. 


Dividend Payout Ratio Formula

The formula for Dividend Payout Ratio calculates the percentage of earnings paid to shareholders in dividends and can be expressed in two ways as shown below.

As an alternative to dividends, some companies prefer to perform stock buybacks  in such cases the Dividend Payout Ratio is less useful.  One way to adapt the payout formula is to include buybacks in the equation.

Adapted Dividend Payout Ratio formula

Dividend Payout Ratio Interpretation

Investors typically size up a dividend stock by looking at its yield.  Payout ratios work in a similar fashion – very high numbers are concerning, while low or moderate numbers tell you a lot about a company's philosophy on paying dividends versus keeping money back to fund future growth.

Payout ratios are also worth consulting to see if a company has the ability to increase its dividend. The fact that a company pays a dividend is not sufficient;  the company must consistently raise the dividend which ultimately causes the share price to go up as well.

Companies that pay higher dividends may be in mature industries where there is little room for growth and paying higher dividends is the best use of profits (utilities used to fall into this group, although in recent years many of them have been diversifying).

It should be noted that the dividends are not paid from earnings; in fact they are paid from cash. The Dividend Payout Ratio compares dividends to the earnings, not to the cash. A company will not be able to pay dividends if it does not have sufficient cash even if it has a high level of earnings.

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