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# Dividend Payout Ratio: What It Is & How To Calculate It

Updated: Sep. 19, 2023By: David Lavie

The dividend payout ratio is a way to measure the relative amount of dividends paid to a company’s shareholders. The ratio is calculated by adding up the dividends paid per share over the past four quarters, then dividing by the total diluted earnings per share for that period. Dividend-minded investors consider it a key metric.

## What Is The Dividend Payout Ratio?

The dividend payout ratio expresses the relationship between a company’s net income and the total dividends paid out, if any, to shareholders. It is a useful tool for understanding what percentage of a company’s earnings has been apportioned to shareholders in dividend form.

Investors seeking to invest in dividend-bearing stocks, whether for growth or income, should understand what the dividend payout ratio means. A high payout ratio could signal a company eager to share its wealth with stockholders, potentially at the cost of further growth. A low payout ratio could mean that the business is investing its earnings in future growth instead of offering current income to shareholders.

## Dividend Payout Ratio Formula & Calculation

The dividend payout ratio formula presents how much of a company's earnings it's currently paying out in dividends. The formula used to calculate the dividend payout ratio is as follows:

Dividend Payout Ratio = Dividends Paid/Net Income

The dividend payout ratio is most commonly calculated on an annual basis, though can be calculated for different periods as well. What's critical is that the same period be used for both the numerator (dividends) and denominator (net income) of the formula.

## What is the Retention Ratio?

The retention ratio is effectively the opposite of what the payout ratio calculation presents. The retention ratio reflects the residual amount of earnings, expressed in %, that are not paid out as dividends.

Retention = 1 - (Dividends Paid/Net Income)

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

Retention Ratio = (EPS-DPS)/EPS

where,

## Dividend Payout Ratio Example

Let’s say Company ABC reports a net income of \$100,000 and issues \$25,000 in dividends.

Payout Ratio = \$25,000 / \$100,000 = 25%

Retention Ratio = \$75,000 / \$100,000 = 75%

ABC company is paying 25% of its earnings out to shareholders in the form of dividends, while retaining 75% of earnings within the corporation.

## Dividend Payout vs. Dividend Yield

While the dividend payout ratio contrasts the amount of a company's dividend with its earnings per share, the dividend yield compares the amount of the dividend paid to the share price. The formula for calculating the dividend yield is:

Dividend Yield = Dividend per share/market price per share * 100

• Dividend yield: compares the size of a dividend with the market price of the underlying stock. It's a handy way to represent the rate of return earned by shareholders on their investment.
• Dividend payout: measures the proportion of a company’s net earnings distributed as dividends to shareholders.

## Dividend Payout Ratio Insights

Dividend yield is relevant to those investors relying on their portfolios to generate predictable income. Dividend payout is a more useful metric for the narrow task of understanding what part of its profits a company chose to distributed to its shareholders, while also being an indicator of the dividend’s sustainability.

How so? As an extreme example: a company with a payout ratio of 100% or more is not retaining any profits inside the company, and may be returning more money to shareholders than it is earning. To maintain its status as a moneymaking enterprise, this company will likely need to reduce the dividend, at least for some time.

Key Note: Companies that pay a low payout ratio are generally seen as having greater ability to sustain the current dividend payment. Companies with high payout ratios may be at greater risk of not earning enough to continue paying the dividend.

## Bottom Line

Useful for assessing a dividend's sustainability, the dividend payout ratio indicates what portion of its earnings a company is returning to shareholders. The retention ratio reflects the portion of earnings that are kept within the corporation to invest in growth, pay off debt or build cash reserves.

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Davíd Lavie is a writer and editor with two decades' experience in marketing communications, equity research and publishing. In his writing for Seeking Alpha, Davíd specializes in educational content. His articles have been published on financial websites including Forbes Advisor, Yahoo Finance, Business Insider and Robb Report. Davíd is a founding partner in Quartet Communications, where, as Head of Creative Content, he helps clients set their work apart by focusing on brand, audience and voice.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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What is defined here is the traditional measure of dividend payout ratio (POR), and this certainly approximates the actual POR, but there is a much better way.

Dividends are paid with cash, not earnings. Earnings is an approximation of cash. Earnings is an standardized estimate that is achieve using accrual accounting. Nothing wrong with that, but what ultimately matters to those who are investing for a long reliable dividend is how much of the available cash is being used to fund the common dividend, and what is the trend over the past, say, 10 quarters. This metric tells you much about the company's ability to sustain and grow the dividend.

The calculation is not difficult, but requires some time to get the company data.

Step 1: Get the Consolidated Funds From Operations (CFFO) over the past 4 quarters. For a company such as Waste Management (WM), this comes off the statement of cash flows and is:

1,120.00 1,043.00 1,184.00 991.00 = CFFO per quarter last 4Q

Step 2: Get the total of any payments made to Preferred shareholders plus distributions to Non-Controlling Interests. The Preferred Dividend distributions will be shown on on the Income Statement after taxes paid while the distribributions to non-controlling interests will be shown in the Financing section of the Statement of Cash Flows. For WM these values are zero.

Step 3: Subtract #2 from #1 for each quarter. This will provide the NET CFFO. For WM this will be the given CFFO values

Step 4: Get the total of Common Dividends paid over the corresponding past 4 quarters. This is available in the Cash Flow from Financing Activities section of the Statement of Cash Flows

(247.00) (242.00) (241.00) (240.00). Note, these values are reported as negative and so must be converted to positive values.

Step 5: divide the quarterly values in Step 4 by the corresponding quarterly values in Step 1. This will give you the payout ratio, or payout % of the dividend to the net operation cash flow. For WM, this comes out to be

22%, 23%, 20%, 24%.

Conclusion: This dividend is very well covered by the company's operational cash.

Many will want to subtract from CFFO, first, the amount the company spent on Capital Expenditures. I disagree. Capital investments can be financed if there is insufficient operational cash to pay them. Dividends are NOT financed...they are paid with cash from operations. If a company is spending gobs of \$\$ on capital expenditures and getting little back in operational cash, this will show up as an increase % of operational cash being used on interest on the debt....which is a subject of another article here on SA.

BruceM