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
- EPS = earnings per share
- DPS = dividends per share
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.
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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