Dividend Payout Ratio


What do you understand by dividend?



Dividend payout ratio definition 

Dividend payout ratio is the ratio between dividends per share and earnings per share.

Dividend payout ratio measures the amount that a company pays out to its shareholders in the form of dividends vis-a-vis the amount the company retains for reinvestments.

* A reduction in dividends paid is looked down upon by investors and the stock price usually depreciates as investors seek other dividend-paying stocks.

* A stable dividend payout ratio is indicative of a solid dividend policy followed by the  board of directors of the company in question.

* This ratio provides an idea to shareholders about how well a company is performing.

* The companies, which are more mature, tend to have a higher payout ratio.

Dividend payout ratio is used in calculating current dividend yield.


Current Dividend yield = (Dividend payout ratio * Most recent full-year earnings per share) / Current Share price


* Profit Earning ratio is the Price / Dividend ratio times the Dividend payout ratio.

Dividend payout ratio becomes less attractive in judging the performance of a company in case the company chooses stock buybacks as an alternative to dividends.

* For small growth companies, dividend payout ratio can be as low as 10%.

* Investors, who are interested in short term earnings, prefer to invest in companies with a high dividend payout ratio.

* On the other hand, investors who prefer to have capital growth, like to invest in companies with a lower dividend payout ratio.

Dividend payout ratio differs from company to company. Mature, stable and large companies usually have a higher dividend payout ratio. Companies, which are young and are looking for growth, have a lower or a modest dividend payout ratio.

* It should be noted that dividends are not paid from “earnings”; in fact, they are paid from “cash”. Dividend payout ratio compares dividends with earnings and not 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.  


Dividend payout ratio analysis

* A shareholder has two sources of return viz. periodic income in the form of dividends and capital appreciation.

* Dividend payout ratio tells about the percentage of total earnings that a company is paying back to shareholders.

* A healthy dividend payout ratio  boosts investor' confidence in a company. 


Dividend payout ratio formula:

Dividend payout ratio = Dividend per share / Earnings per share


Dividend per share = Total dividend amount / Number of equity shares outstanding

Earnings per share = Net income / Number of equity shares outstanding


Dividend payout ratio = Total Dividend / Net income


Dividend payout ratio can also be equated as

Dividend payout ratio = 1 – Retention rate

* The retention ratio and the dividend payout ratio together equal 1 or 100% of net income.

* The premise is that whatever amount is not paid as dividends is retained by a company so that it could reinvest it for expansion.

Dividend payout ratio = (Dividends-Preferred stock dividends)/Net earnings


Dividend Payout Ratio
Source: http://www.12manage.com/images/picture_dividend_payout_ratio.gif 


What are the steps for calculating the dividend payout ratio?

Dividend payout ratio calculation is done in five steps, which are as follows:

* Determine the net income of the company.

* Determine the dividend payment level.

* Divide the dividend amount by net income.

* Remember that strictly speaking, dividend payout ratio measures the dividend payout to common shareholders; so, the dividend attributable to preferential shares will be subtracted from the total dividends.


Let us make this concept clear by taking a few dividend payout ratio examples:

Example 1


Dividend per share = $5

Earnings per share = $9

Dividend payout ratio = Dividend per share / Earning per share

= $5 / $9

= 55.55 %


Example 2


Total net is income $50000.

Dividend distributed to equity shareholders is $10000.

Dividend payout ratio = Total Dividend / Net income

= $10000/ $50000

= 20%


Example 3


Retention rate = 60%

Dividend payout ratio = 1 – Retention rate

= 100% – 60%

= 40%


Example 4


Earnings per share = $15

Retained earnings per share = $7

Dividend payout ratio = Dividend per share / Earning per share

= (Earnings per share - Retained earnings per share)/ Earning per share

= ($15 - $7) / $15

= $8 / $15

= 53.33%


Some of the questions on dividend payout ratio our experts have answered are:

Q How does the dividend payout ratio affect the amount of funds needed to finance growth? 


Q Quantem Aviation earned $10 million dollars last year and retained $6 million. What is its payout ratio?


Q What is the difference between dividend payout ratio and retention ratio?


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