What is dividend payout ratio?

The total amount ratio of dividends paid out to the shareholders relative to the company’s net income is the dividend pay-out ratio. It is the percentage of earnings that are paid to the shareholders in dividends. The company may retains the amount that is basically not paid to shareholders to pay off debt or reinvest in core operations. It is sometimes referred to as the ‘pay-out ratio.’

The dividend pay-out ratio usually indicates how much money a company can return to the shareholders versus how much it can keep in its hands to reinvest in growth, paying off the debts, or add to cash reserves (retained earnings).

What does the dividend payout ratio tells you?

Some considerations go into interpreting the dividend pay-out ratio; it is most important for its maturity level.

A new, growth-oriented company aiming to expand, develop new products, and move into new markets would be expected for reinvesting most of its earnings and be forgiven for having a lower or even zero pay-out ratio.

The pay-out ratio is 0% for the companies that do not pay or fail to pay dividends and are 100% for those companies that pay out their entire net income.

On the other hand, an older or a well-established type of a company that has been returned their money back to the shareholders would test investors’ patience and even being a tempt activists to intervene.

In 2012 and after nearly about a twenty years as paid the last dividend. Once AAPL began to mainly pay a dividend when a new CEO has felt that company’s enormous type of cash flow is making a 0% pay-out ratio it has become difficult to justify.

Since it is implied that a company is moving past its initial growth stage, a high pay-out ratio means share prices are unlikely to appreciate rapidly.

Formula and calculation of dividend payout ratio

Dividend Payout Ratio  = Dividends / Net Income

The dividend payout ratio is a calculation that can be done as the yearly dividend per share is mainly divided by the earnings per share of the company, or equivalently, type of  dividends divided by net income (as shown below).

Alternatively, there is another way to calculate the dividend payout ratio:

On a basically per-share basis, when we expressed a retention ratio.

What is the average dividend payout ratio?

The average dividend payout  is likely vary dramatically. It also mainly depends on the priorities of company. If they are in a high-growth phase, for example, all profits are likely to be reinvested in the business, which means that the dividend payout ratio can be minimal. However, companies that may not be focused on a growing which been likely to have much higher type of average dividend payout ratios.

The average dividend payout ratio can also be vary significantly from one type of industry to another type of industry. E.g., companies from the any type of tech industry tend to have much lower payout ratios than when we compare it with utility companies. 

Generally speaking, a 30-50% dividend payout ratio can be considered healthy, while anything over 50% can be unsustainable.

What is dividend sustainability in dividend payout ratio?

The payout ratio is considered useful for assessing a dividend’s sustainability. Companies that are extremely reluctant to cut dividends can drive the stock prices down and reflect poor management’s abilities. 

If a company is paying out a ratio over 100%, it will return more money to the shareholders than earnings. It will be probably forced to lower the dividend or even stop paying it altogether. This result is not inevitable. 

However, a company that is enduring a bad year without suspending payouts, then it is often in their interest to do so. Therefore, it is important to consider future earnings expectations and calculate a forward-looking payout ratio to contextualize the backwards-looking one.

Sometimes a long-term may trend in the payout ratio will also matters. A steady rise in ratio can also indicate a healthy, maturing business, but a spiking one can mean that the dividend is headed into unsustainable territory.

Hence, the retention ratio is a converse concept towards the dividend payout ratio. The dividend payout ratio can also evaluate the percentage of profits earned that a company pays out to its shareholders.

While the retention ratio also been represents that the percentage of any profits can be earn that are retained by or reinvested in the company.

Alternative Method for calculating Dividend payout Ratio

Dividend Payout Ratio  = 1 –  Retention Ratio

How to evaluate dividend sustainability?

You can infer other information about a company’s strength with the DPR, such as the dividend’s level of sustainability. 

Companies have a motivation to pay dividends at a level they know they can sustain rather than offering an aggressive dividend to please shareholders. Some companies also have learned that the hard way of cutting dividends upsets shareholders, drives down the company’s stock price, and reflects poorly on the management team’s abilities.

Following a firm’s type of dividend payment trends over time a sheds additional insight. If a company’s DPR rises over a period of time, it could indicate that it is maturing into one of healthy and a stable operation. Conversely, if the dividend spikes up, the company could have trouble sustaining such a high dividend in future periods.

Regardless, it’s important to view the any DPR in the company’s industry, context, and a competitors. Although the ratio are offers some insight, companies is providing shareholder value in any other ways than dividend payments. For instance, having a  enough cash flow which will avoid taking on a debt has a value in the long term.

If a company’s dividend payout ratio exceeds 100%, the company pays out more in dividends than the cash company is taking in. It is also not a sustainable strategy over time if the company is wishing to remain in business. Sometimes companies may do this when they are mainly losing money and they do not want shareholders to sell their stock.

Thus, tracking changes in a firm’s DPR over time provides a much more meaningful analysis.

Dividends industry specific-

Dividend payouts can also be vary widely by any industry, and like most other ratios. They are also most useful for comparing within a given industry. 

Real estate investment partnerships, for example, if the companies are legally obligated for distributing at least 90% of the earnings to shareholders as they enjoy special tax exemptions. Master limited partnerships tend to have a high payout ratio.

 As we can see that dividends are not have been only a way companies can get return the value to their shareholders; therefore, the payout ratio is not always provided by a complete picture. The augmented payout ratio also incorporates share buybacks into the process. 

This way can also been calculate by dividing a sum of dividends and a buybacks by net income earned for a particular period. If the result is too higher, it can emphasize short-term boosts to share prices at the expense of reinvestment and long-term growth.

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

Example of dividend payout ratio-

Companies that earn profit at the end of a fiscal year can do several things with their profit. They can even pay it to the shareholders as dividends; they can also retain it to reinvest in the

Growth business or they can do both. The profit that the company chooses to pay out to its shareholders can also be measured with the pay-out ratio.

E.g., on November 29, 2017, The Walt Disney Company have declared that a $0.84 semi-annual cash dividend per share to shareholders is the record December 11, 2017, which is to be paid on January 11, 2018.

As of the fiscal year, which ended on September 30, 2017, the company’s EPS was $5.73, and its pay-out ratio is, therefore, ($0.84 / $5.73) = 0.1466, or 14.66%. Disney will pay-out 14.66% and retain 85.34%.

What is a good dividend payout ratio?

Investors who are Dividend-hungry tend to look for the best yielding they can find.

It can also be dangerous to get too greedy, as a high yielding is a big dividend relative to the share price often means taking on many risks.

Experts say that it is wise to look at another gauge: the dividend pay-out ratio or the percentage of earnings paid as dividends. The higher the figure, the greater the company’s risk, as it would not avoid a dividend that cuts if things go wrong.

In extreme cases, the firms pay out more than they are earning, a red flag signalling the need for a deeper look is to determine if it is a freak event or a sign of trouble like tumbling earnings.

What is a safe dividend payout ratio?

A safe dividend pay-out ratio is varied by the industry and a company’s overall profile of finance.

E.g., if one company is operating in a stable sector might safely maintain a high dividend pay-out ratio of 75% of their earnings because it would have a strong balance sheet.

On the other hand, if a competitor in that same industry has a weaker financial profile, it might not sustain its dividend if it has to be a high pay-out ratio.

As it is considered, the safest dividend pay-out ratio has been around 41%, according to the research by the institute named Wellington Management and Hartford Funds.

More dividend stocks with a pay-out ratio which are averaging around that level have to outperform the S&P 500 than those having other pay-out levels.

That is because they can even pay an attractive dividend yield while retaining a significant amount of money for expanding their business and use it on other shareholder-friendly activities like share repurchases and debt repayment.

How to interpret the dividend payout ratio?

Whether 33% equates to a good or bad pay-out completely depends on the interpretation.

Growing companies are typically retaining more of their profits to fund growth, which offers more favourable dividends in the future. At the same time, it also offers lower or no dividends in the present.

Companies paying higher dividends may be in matured industries with little room for additional growth, so paying higher dividends can stand as the best use of profits.

An industry with one specific product line would fall into this group. If that industry began to diversify one good example is utility companies it would become more appropriate to divert some profits into future investment in fixed assets.

What is the difference between a dividend payout ratio and a cash dividend payout ratio?

The cash dividend pay-out ratio is a less commonly used ratio than the dividend payout ratio. It helps measure the relationship between a company’s dividends and its cash flow from operations, minus capital expenditures and preferred dividends.

FORMULA-

E.g., if a company is producing 50 million USD in cash flow, and pays 5 million USD in dividends to common shareholders, then pays 1 million USD in dividends to all preferred shareholders, and later makes $20 million in capital expenditures, then its cash dividend pay-out ratio will be: 5 million USD (50 million USD – 1 million USD – 20 million USD) = 17.24%

It can argue proponents of the cash dividend pay-out ratio that it would be a better ratio to use. One of the reasons is that it is a more accurate indication of whether a company can sustain its dividend payments.

Companies will also usually try very hard to maintain their dividends, as cutting dividends due to cash flow issues can cause investors to sell out of stock.

The cash dividend pay-out ratio is also considered as capital expenditure that helps in ensuring that the company can keep operating in the future. If the cash dividend pay-out ratio is too high, it indicates that a company is stretching itself thin to maintain its dividend.

For example, a cash dividend ratio over 100% means the company depletes savings for making their payments. Anything above 85% is likely to stay unsustainable unless things change.

What is the difference between a dividend payout ratio and dividend yield?

The dividend payout ratio is considered a measurement of a company’s dividend compared to its earnings per share. Just as a price-to-earnings ratio compares a company’s earnings to its stock price, dividend yield (EPS) measures a company’s dividend compared to its stock price.

You can only calculate a company’s dividend payout ratio when it files financial reports that include information about its earnings per share and planned dividends. By contrast, a company’s dividend yield changes all the time. Whenever the stock price changes, its dividend yield also changes.

E.g., on September 12, 2019, Coca-Cola closed at 55.30 USD and paid an annual dividend of 1.60 USD. Then that means that its dividend yield was:

1.60 USD / 55.30 USD = 2.89%

When the market was closed on October 7, 2019, Coca-Cola closed at 53.87 USD and an annual dividend of 1.60 USD. That makes its dividend yield:

1.60 USD / 53.84 USD = 2.97%

Even though the dividend did not change, the price change can result in changes in the dividend yield.

Income-focused investors stay curious to look at the dividend yield because it indicates what cash return they’ll earn on the money they put into the investment based on the stock price when they buy it.

Dividends Are Industry Specific-

Dividend pay-outs can vary widely by industry, and like most other ratios, they can be most useful to compare within a given industry.

E.g., real estate investment partnerships are legally obligated to distribute at least 90% of their earnings to the shareholders as they can enjoy special tax exemptions.

Master limited partnership tends to have high pay-out ratios.

Dividends are not the only way the companies can return value to their shareholders; therefore, the pay-out ratio does not always provide a complete picture.

The augmented pay-out ratio usually incorporates share buybacks into the metric; it can also be calculated by dividing the dividends and buybacks by various net incomes for the same period. If the result is higher, it can emphasize short-term boosts to share prices at the expense of reinvestment and long-term growth.

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

Frequently Asked Questions-

What does the payout ratio tell you?

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

 

How do you calculate the dividend payout ratio?

The dividend pay-out ratio is commonly calculated per share by dividing annual dividends by earnings per share (EPS).

 

Is a high dividend payout ratio good?

– Active investors do not always value a high dividend pay-out ratio. An unusual higher dividend pay-out 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 use working capital to expand aggressively.

Analysts would prefer to see a healthy balance between dividend pay-outs and retain earnings. They can also like to see consistent dividend pay-out ratios from year to year, indicating a company is not going through boom-and-bust cycles.

 

What is the difference between the dividend payout ratio and dividend yield?

– While comparing the two measures of dividends, it is important to know that the dividend yield tells you about the simple rate of return in the form of cash dividends to shareholders. 

Still, the dividend payout ratio can represent how much of a company’s net earnings are paid out. While the dividend yield can be more commonly known and scrutinized, many believe the dividend payout ratio is a better indicator of a company’s ability to distribute dividends consistently in the future.