What is the Dividend Payout Ratio?

Key Points

• The Dividend Payout Ratio(Payout Ratio) is a metric used by analysts to capture the portion of net income paid to common stockholders in the form of cash payments. 
• The cash payments not granted to common stockholders are referred to as retained earnings and can be used towards paying off debt, capital investments/expenditures, or added to the cash stockpile on the balance sheet. 
• Whether or not a company elects to pay a dividend is entirely dependent on the board of directors and can often reflect the viewpoint upper management has on how they want to reward shareholders.
• There is a balance between paying money out to shareholders and reinvesting profits into growing the company. This ratio can vary from industry to industry depending on growth opportunities. 

The Dividend Payout Ratio(Payout Ratio) can easily be calculated using the below formula or you can always use Google to search for the exact percentage as well.

Dividend Payout Ratio=Dividends Paid/Net Income

What Does The Dividend Payout Ratio Tell Investors?

The payout ratio can provide valuable insight when it comes to making investment decisions. Amongst this can include a company’s level of maturity in terms of growth and whether or not they will be able to continue to grow in a sustainable fashion.

It is encouraging to see a company historically growing their dividend but it is important to make sure it is sustainable. This can be a reflection of a proven track record in upper management and further emphasize Why Investing in Leadership Matters.

For high growth companies in their early stages or established Blue Chip Growth names, it is likely they will pay out a smaller portion of their earnings in the form of dividends or elect to not pay a dividend at all. 

This is because upper management believes they will be able to reward you more as a shareholder by reinvesting a larger portion of their earnings (net income) into R&D. 

Their strategy is to further grow the company’s revenue by continuously developing innovative products and services within their fast growing industry and continue to grab more market share. This will hopefully assist with generating higher Free Cash Flow(FCF) and will allow them to pay and grow an attractive dividend as the company moves forward. 

Stable Companies. Stable Dividend Growth. Investor Income

When it comes to a more established company, there is a good chance a larger portion of the company’s earnings will go towards rewarding shareholders in the form of dividends. 

This is because the growth prospects are not as attractive since the company has moved on from their early business stages. 

Thus, upper management will elect to reward shareholders with more attractive dividend payments in comparison to other companies. It is still important for even an established company to continue to grow their revenue and Free Cash Flow(FCF). 

It will allow for sustainable dividend growth because no company wants to have to slash their dividend because they paid out too much at once.

They want Investors Happy but They Need to Reinvest for Dividend Growth

All in all, a general rule of thumb is to make sure a company is not paying out more than 75% of their earnings in the form of dividend payments when it comes to the Dividend Payout Ratio. 

While it is normal for more established companies to have a higher dividend payout ratio, investors want to feel confident knowing a portion of earnings will be retained in the company to ensure some growth is achieved so the company can sustainably grow their dividend and continue to reward shareholders in the future.