Dividend Payout Ratio Definition, Formula, and Calculation (2024)

What Is a Dividend Payout Ratio?

The dividend payout ratio is the total amount of dividends that a company pays to shareholders relative to its net income. Put simply, this ratio is the percentage of earnings paid to shareholders via dividends. The amount not paid to shareholders is retained by the company to pay off debt or to reinvest in its core operations. The dividend payout ratio is sometimes simply referred to as the payout ratio.

Key Takeaways

  • The dividend payout ratio is the proportion of earnings paid to shareholders as dividends.
  • Some companies pay out all their earnings to shareholders, some only pay out a portion of their earnings, while others don't pay any dividends to shareholders at all.
  • The portion of earnings that isn't paid is called the retention ratio.
  • Several considerations go into interpreting the dividend payout ratio, most importantly the company's level of maturity.

Dividend Payout Ratio Definition, Formula, and Calculation (1)

Formula and Calculation of Dividend Payout Ratio

The dividend payout ratio can be calculated as the yearly dividend per share divided by the earnings per share (EPS), or equivalently, the dividends divided by net income (as shown below).

DividendPayoutRatio=DividendsPaidNetIncome\begin{aligned} &\text{Dividend Payout Ratio} = \frac{ \text{Dividends Paid} }{ \text{Net Income} } \\ \end{aligned}DividendPayoutRatio=NetIncomeDividendsPaid

Alternatively, the dividend payout ratio can also be calculated as:

DividendPayoutRatio=1RetentionRatio\begin{aligned} &\text{Dividend Payout Ratio} = 1 - \text{Retention Ratio} \\ \end{aligned}DividendPayoutRatio=1RetentionRatio

On a per-share basis, the retention ratio can be expressed as:

RetentionRatio=EPSDPSEPSwhere:EPS=EarningspershareDPS=Dividendspershare\begin{aligned}&\text{Retention Ratio} = \frac{ \text{EPS}-\text{DPS} }{ \text{EPS} } \\&\textbf{where:}\\&\text{EPS}=\text{Earnings per share} \\&\text{DPS}=\text{Dividends per share}\end{aligned}RetentionRatio=EPSEPSDPSwhere:EPS=EarningspershareDPS=Dividendspershare

The dividend payout ratio indicates how much money a company returns to shareholders versus how much it keeps to reinvest in growth, pay off debt, or add to cash reserves.

Calculating the Dividend Payout Ratio in Excel

If you are given the sum of the dividends over a certain period and the outstanding shares, you can calculate thedividends per share (DPS). Suppose you are invested in a company that paid $5 million last year with five million shares outstanding. On Microsoft Excel, enter:

  • "Dividends per Share" into cell A1.
  • "=5000000/5000000" in cell B1, which means the dividend per share is $1 per share.
  • "Earnings per Share" into cell A2

Suppose the company had a net income of $50 million last year. The formula for earnings per share is (Net Income - Dividends on Preferred Stock) ÷ (Shares outstanding), enter

  • "=(50000000 - 5000000)/5000000" into cell B2, which means the EPS for this company is $9

Finally, calculate the payout ratio by entering:

  • "Payout Ratio" into cell A3
  • "=B1/B2" into cell B3, which gives a payout ratio of 11.11%

Investors use the ratio to gauge whether dividends are appropriate and sustainable. The payout ratio depends on the sector. For example, startups may have a low or no payout ratio because they are more focused on reinvesting their income to grow the business.

Understanding the Dividend Payout Ratio

The dividend payout ratio is 0% for companies that do not pay dividends and 100% for companies that pay out their entire net income as dividends.

Several considerations go into interpreting the dividend payout ratio—most importantly the company's level of maturity.

  • A new, growth-oriented company that aims to expand, develop new products, and move into new markets would be expected to reinvest most or all of its earnings and could be forgiven for having a low or even zero payout ratio.
  • An older, established company that returns a pittance to shareholders would test investors' patience and could tempt activists to intervene to boost the payout ratio.

In 2012 and after nearly twenty years since its last paid dividend, Apple(AAPL) began to pay a dividend when the new chief executive officer (CEO) felt the company's enormous cash flow made a 0% payout ratio difficult to justify. Since higher dividends are often a sign that a company has moved past its initial growth stage, a higher payout ratio means share prices are unlikely to appreciate rapidly.

Dividend Sustainability

The payout ratio is also useful for assessing a dividend's sustainability. Companies are extremely reluctant to cut dividends because it can drive the stock price down and reflect poorly on management's abilities. If a company's payout ratio is over 100%, it returned more money to shareholders in the year it earned and may be forced to lower the dividend or stop paying it altogether since overpayment is likely to be unsustainable.

A company may endure a bad year withoutsuspending payouts. It is often in its interest to do so because investors will expect a dividend. Not paying one can be an extremely negative signal about where the company is headed. Investors react badly to companies paying lower-than-expected dividends, which is why share prices fall when dividends are cut.

Long-term trends in the payout ratio also matter. A steadily rising ratio could indicate a healthy, maturing business, but a spiking one could mean the dividend is heading into unsustainable territory.

The retention ratio is a converse concept to the dividend payout ratio. The dividend payout ratio evaluates the percentage of profits earned that a company pays out to its shareholders, while the retention ratio represents the percentage of profits earned that are retained by or reinvested in the company.

Dividends Are Industry Specific

Dividend payouts vary widelyby industry, and like most ratios, they are most useful to compare within a given industry. For example, real estate investment trusts (REITs) are legallyobligated to distribute at least 90% of earnings to shareholders as they enjoy specialtax exemptions. Master limited partnerships (MLPs) tend to have high payout ratios, as well.

Dividends are not the only way companies can return value to shareholders. Therefore, the payout ratio does not always provide a complete picture. The augmented payout ratio incorporates sharebuybacksinto the metric, whichis calculated by dividing the sum of dividends and buybacks by net income for the same period. If the result is too high, it can indicate an emphasis on short-term boosts to share prices at the expense of reinvestment and long-term growth.

Another adjustment that can be made to provide a more accurate picture is to subtract preferred stock dividends for companies that issue preferred shares.

Dividend Payout Ratio vs. Dividend Yield

When comparing these two measures, it's important to know that thedividend yieldtells you what the simple rate of return is in the form ofcash dividendsto shareholders, but thedividend payout ratiorepresents how much of a company's net earnings are paid out as dividends.

While the dividend yield is the more commonly known and scrutinized term, many believe the dividend payout ratio is a better indicator of a company's ability to distribute dividends consistently in the future. The dividend payout ratio is highly connected to a company'scash flow.

Thedividend yield shows how much a company paid out in dividends a yearas a percentage of the stock price. It shows for a dollar spent on the stock how much you will yield in dividends. The yield is presented as a percentage, not as an actual dollar amount. This makes it easier to see how much return per dollar invested the shareholder receives through dividends.

The yield is calculated as:

DividendYield=AnnualDividendsperSharePriceperShare\begin{aligned} &\text{Dividend Yield} = \frac{ \text{Annual Dividends per Share} }{ \text{Price per Share} } \end{aligned}DividendYield=PriceperShareAnnualDividendsperShare

For example, a company that paid $10 in annual dividends per share on a stock trading at $100 per share has a dividend yield of 10%. You can also see that anincrease in share pricereduces the dividend yield percentage and vice versa for a price decline.

Example of the Dividend Payout Ratio

Companies that make a profit at the end of a fiscal period can do several things with the profit they earn. They can pay it to shareholders asdividends, they can retain it to reinvest in the growth of its business, or they can do both. The portion of the profit that a company chooses to pay out to its shareholders can be measured with the payout ratio.

For example, Apple (AAPL) has paid $0.87 per share in dividends over the trailing 12 months (TTM) as of Jan. 3, 2022. Apple's EPS over the TTM has been as follows:

  • Q1 2021: $1.70
  • Q2 2021: $1.41
  • Q3 2021: $1.31
  • Q4 2021: $1.25

The TTM EPS for Apple is $5.67 as of Jan. 3, 2022. Thus, its payout ratio is 15.3%, or $0.87 divided by $5.67.

Why Is the Dividend Payout Ratio Important?

The dividend payout ratio is a key financial metric used to determine the sustainability of a company’s dividend payment program. It is the amount of dividends paid to shareholders relative to the total net income of a company.

How Do You Calculate the Dividend Payout Ratio?

Itis commonly calculated on a per-share basis by dividing annual dividends per common share by earnings per share.

Is a High Dividend Payout Ratio Good?

A high dividend payout ratio is not always valued by active investors. An unusually high dividend payout ratio can indicate that a company is trying to mask a bad business situation from investors by offering extravagant dividends, or that it simply does not plan to aggressively useworking capitalto expand.

What Is the Difference Between the Dividend Payout Ratio and Dividend Yield?

When comparing the two measures of dividends, it's important to know that the dividend yield tells you what the simple rate of return is in the form of cash dividends to shareholders, but the dividend payout ratio represents how much of a company's net earnings are paid out as dividends.

The Bottom Line

Some companies decide to reward their shareholders by sharing their financial success. This happens through dividends, which are paid at regular intervals to shareholders throughout the year. The dividend payout ratio is the total amount of dividends that companies pay to their eligible investors expressed as a percentage.

Dividend Payout Ratio Definition, Formula, and Calculation (2024)

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