Dividend Payout Ratio

A dividend payout ratio is an important financial computation of the percentage of net income which is paid out to common and preferred shareholders.  It is calculated by dividing the total dividends paid into the net income. The ratio is calculated in the following manner:

Dividend Payout Ratio = Total Dividends (Common and Preferred) divided by Net Income

This is least frequently used value ratio because its overall assessment potential is limited. Generally, companies do not use a percentage payout ratio to set the dividend.  They are much more likely to set a fixed dividend, regardless of yearly income level, which can make the dividend payout ratio fluctuate sharply from period to period. Once useful piece of information for financial analysts is whether a company regularly pays dividends to shareholders. Companies expecting rapid growth generally reinvest earnings back into the business rather than paying them out to shareholders. Alternatively, companies that pay out regularly dividends, particularly on common shares, are giving strong indications that rapid growth is not on the horizon.

As companies get larger, management very often favors instituting a dividend to disburse cash reserves in order to maintain the return on equity ratio at acceptable levels. There comes a point with many large, cash rich companies where management cannot reinvest the money in businesses that generate the kind of returns that investors have come to expect. It is better in that situation to divided cash out to shareholders rather than depressing returns through the investment of substantial cash in low return investment securities. The presence or absence of a dividend payout can often tell more than the actual payout percentage in a given period.

Questionnaire:

• What is dividend payout ratio?
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