Dividend Payout Ratio
Dividend payout ratio compares the dividends paid by a company to its earnings. The relationship between dividends and earnings is important. The part of earnings that is not paid out in dividends is used for reinvestment and growth in future earnings. Investors who are interested in short term earnings prefer to invest in companies with high dividend payout ratio. On the other hand, investors who prefer to have capital growth like to invest in companies with lower dividend payout ratio.
Dividend payout ratio differs from company to company. Mature, stable and large companies usually have higher dividend payout ratio. Companies which are young and seeking growth have lower or modest dividend payout ratio.
Investors usually seek a consistent and/or improving dividends payout ratio. The dividend payout ratio should not be too high. The earnings should support the payment of dividends. If the company pays high levels of dividends it may become for it to maintain such levels of dividends if the earnings fall in the future. Dividends are paid in cash; therefore, high dividend payout ratio can have implications for the cash management and liquidity of the company.
Dividend payout ratio Calculation (formula)
The formula for calculation of dividend payout ratio is given below:
Dividend Payout Ratio = Total Dividends / Total Net Earnings x 100%
Dividends payout ratio can also be calculated with the help of following formula
Norms and Limits
It should be noted that the dividends are not paid from “earnings”; in fact they are paid from the “cash”. Dividend payout ratio compares dividends to the earnings, not to the cash. A company will not be able to pay dividends if it does not have sufficient cash even if it has a high level of earnings.
You can find industry benchmarks for dividend payout ratio in our reference book.