Dividend payout ratio is one of the most important financial ratios that can be used not only to pick stocks for your portfolio but to also understand if a company has a consistent dividend policy. The dividend payout ratio shows you what’s the dividend that was paid out by a company compared to the income generated during the year.
There are many companies nowadays that try to achieve capital appreciation by investing the profits generated in other projects that will bring more profits and so on. The dividend payout ratio for these companies are lower compared to companies that choose to return their profits back to the shareholders.
Dividend Payout Ratio Formula
You can find the dividend payout ratio with two different (but similar) formulas. The first formula is :
Dividend Payout Ratio= (Total Dividends Paid/Net Income Available to the shareholders)
The second formula works on a per share basis and it is as follows:
Dividend Payout Ratio=(Dividend Per Share/Earnings Per Share).
Of course, both formulas will give you the same number.
Dividend Payout Ratio Analysis
As explained above, the dividend payout ratio shows the dividend that a company distributes compared to the net income generated during the year.
So what does a high dividend payout ratio mean? It means that a company chooses to distribute a big part of its income to the shareholders instead of investing in projects. Of course, this can be both good and bad. It’s good because the investors get a return on the funds they have invested and it’s also bad because it means that a company might be unable to find profitable projects or that it operates in a mature industry with limited opportunities.
Dividends used to be the standard form of profits distribution but nowadays companies also use share repurchases. Therefore, when the dividend payout ratio is calculated and it appears to be low, it might be the case that a company prefers to buy-back its shares instead of paying out dividends.
As noted above, it’s not that uncommon for companies to choose not to pay dividends (for many years in certain occasions). Apple and Microsoft are two good examples. Apple paid dividends in 2012 after around 7 years. In addition, Microsoft paid a dividend in 2003 but went public back in 1986. However, both companies had impressive capital appreciation so the investors had a decent return on their investment.
Therefore, when analyzing the dividend payout ratio, it’s important to understand if a company offers buybacks, if there is capital appreciation and above all, if the dividend payout ratio fluctuates. A dividend payout ratio that changes a lot over time can mean either that the company does not have stable profits or that the dividend policy is not consistent.
Both scenarios are not ideal since investors are interested in knowing when they will recoup their investment and what this return will be. For this reason, the market seems to be less forgiving for companies that have dividend payout ratio that changes a lot over time.
Dividend Payout Ratio Calculator
The dividend payout ratio calculator found below uses the second formula which calculates the dividend payout ratio based on the earnings and the dividends distributed per share.
Therefore, the only input needed is the dividend per share for the numerator and the earnings per share for the denominator.