The dividend payout ratio (DPR) is the amount of money that a company pays in dividends to its shareholders in comparison to its net income. Because it is a ratio, it is expressed as a percentage.
First of all, a “dividend” is an amount of money paid back to investors who own shares of a publicly-traded company. It is not a return on their initial investment, but the income generated from the investment. It is based on the company’s total net income, which is their income after cost, expenses, overhead, taxes, etc.
If you are running a company, how do you know how much to pay your shareholders? Or, from the shareholders perspective, what do the dividends tell you about the health of a company? This is where the dividend payout ratio comes in to play. While just looking at the DPR won’t tell you everything you need to know, it can give you a good indication of how the company handles its growth.
The dividend payout ratio gives shows you what they are paying out in proportion to what they are earning. The results of the DPR, however, are subject to interpretation. The analysis of their DPR percentage can vary depending on the market and industry. Generally, fledgeling companies will have a lower ratio since money not paid out will go towards debt paydown and growth investment.
Dividend Payout Ratio Formula
$$Dividend\: Payout\: Ratio = \dfrac{Dividend\: per\: Share}{Earnings\: per\: Share}$$
In this equation, the “dividends per share” is the cash value of the money paid to shareholders for each individual share they hold. The “earnings per share” is essentially the full potential that each share would receive if all of their net income were evenly distributed. For example, if a company had $1000 in net income with 100 total shares, each shareholder has the potential to receive $10 per share.
You can also calculate the dividend payout ratio by dividing the total dividends paid by the net income:
$$Diviend\: Payout\: Ratio = \dfrac{Dividends\: Paid}{Net\:Income}$$
Once you have your ratio, you need to know how to apply it. What does this percentage mean, and how does it affect the company and its shareholders? While different industries will have different standards for dividends, here are some general guidelines.
A DPR of less than 30% to 35% is a safe ratio. Businesses starting out would pay these dividends and, hopefully, will launch from there. While the dividends would be low, this is a good place to start investing if you believe the company has potential. If the ratio is less than 0%, the company would be losing money.
From that point, a DPR of up to about 50% would be very positive. This would mean that the business would be taking half its earnings to pay towards shareholders. Conversely, it would be able to put the other half towards debt payoff and growth. A business in this range is probably heading its industry.
Once you go higher than this, things get a little riskier. Beyond that percentage, the company would reduce what they had available to use for growth and moving forward. A company that gives three quarters or more of their net income to shareholders is probably not looking forward towards the future of their company. If you reach a point where you are sacrificing progress for dividends, you should quickly re-evaluate the direction your company is taking.
Finally, if a business has a DPR of over 100%, they are handing out more than they are taking in. This is a major red flag for shareholders and investors.
Dividend Payout Ratio Example
Daniel wants to evaluate the health of a restaurant chain he has invested in. The company has distributed $4.73 per share for the last quarter. They have earnings per share amount of $8.97.
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Dividends Per Share: $4.73
- Earnings Per Share: $8.97
We can apply the values to our variables and calculate the dividend payout ratio:
$$Dividend\: Payout\: Ratio = \dfrac{4.73}{8.97} = 52.73\%$$
In this case, the restaurant chain’s dividend payout ratio would be 0.5273 or 52.73%.
Based on our understanding of the breakdown for DPR results, we can see that the company is probably doing very well. They are producing sustainable dividends that can keep shareholders happy while still keeping enough cash flow to produce growth.
Dividend Payout Ratio Analysis
The dividend payout ratio is a great means to determine whether or not a company has the cash flow to support the dividends they are paying at an ongoing rate. For example, a company will not be able to continually pay dividends that equal the full earnings per share, or 100% DPR.
You may be wondering why a company would choose to pay dividends of over 100%. If a company is not doing well, they will sometimes choose to increase their dividends to keep shareholders happy and distracted. They are hoping that these dividends will keep the investors from selling their shares and pulling out. But there is no way to keep this going over the long term.
Ideally, a company should grow their dividends slowly. They should only distribute money at a rate they feel comfortable offering consistently in the future. If a company’s payout shoots up quickly, they may not be able to sustain it and will likely have to cut dividends later.
Consequently, cutting dividends can cause shareholders to feel uneasy about the future of the company. This can lower the price per share and make the company look bad. On the other hand if the DPR is steadily increasing, the company will be seen as stable and forecasting a better future.
Dividend Payout Ratio Conclusion
- The dividend payout ratio is the amount of money that a company pays in dividends to its shareholders in comparison to its net income.
- This formula uses requires two variables: dividends per share and earnings per share.
- A dividend payout ratio is industry-specific but is usually healthy between 30 and 50%.
- If the ratio is less than 0% or over 100%, the company is probably losing money.
Dividend Payout Ratio Calculator
You can use the dividend payout ratio calculator below to get an estimate of how much is being paid to shareholders compared to a company’s earnings by entering the required numbers.