What is Dividend Payout Ratio?
What Is the Dividend Payout Ratio?
A company may either decide to reinvest its earnings back into the business, or pay out its earnings to shareholders—the dividend payout ratio is what percent of earnings is paid out to shareholders as a dividend.
Dividend Payout Ratio Formula
The formula for the dividend payout ratio is Dividends Paid divided by Net Income.
Why Payout Dividends
New companies still in their growth phase often reinvest all or most of their earnings back into their business, whereas more mature companies often pay out a larger percentage of their earnings in the form of dividends.
The purpose of paying out dividends is to incentivize investors to hold shares of a company’s stock.
Investors may hold onto a company’s stock with the belief that their compensation will come through appreciating stock prices, dividend payouts, or a mix of both.
In general, high payout ratios mean that share prices are unlikely to appreciate rapidly since the company is using its earnings to compensate shareholders rather than reinvest those earnings for future growth.
The Bottom Line
The dividend payout ratio is useful for assessing the following:
- trajectory of the company—a consistent and steadily rising ratio may suggest a company is has healthy cash flows and is still maturing
- short-term stock prices—if a company has a dividend payout ratio of more than 100%, it may be attempting to inflate stock prices in the short term
- comparing stocks within an industry—dividend payout ratios should not be compared across industries where expectations of dividend payouts may vary greatly
- maturity of a company—more mature companies tend to have higher payout ratios