What Is Dividend Payout Ratio?
The dividend payout ratio is a type of financial ratio that compares the dividends paid by a company relative to its net earnings. In the other sense, it calculates the percentage of profit distributed to the shareholders as dividends.
The dividend payout ratio is different from the dividend yield as dividend yield compares the dividend payment with the current stock price.
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Formula And Calculation Of Dividend Payout Ratio
The dividend payout ratio can be calculated by dividing the dividends paid by the net earnings or profit.
The formula for Dividend Payout Ratio is:
Dividend Payout Ratio = Dividend Paid/Net Profit
The dividend paid and net profit figures can be collected from the Profit and loss statement easily.
Example
Suppose, A company earned a net profit of $100 million and issued $20 million as dividends to its shareholders. So what will be the dividend payout ratio?
Dividend payout ratio = $20 million/$100 million = 0.2 or in percentage term 20%.
A 20% dividend payout ratio means a company is paying 20% of its net income to its shareholders as dividends and keeping the rest 80% as the retained earnings for the company’s future growth and expansion.
What High And Low DPR Tells You
High DPR
A higher dividend payout ratio means that the company is a mature one and reinvesting very little money into its exiting business while paying out relatively more of its profit as dividends. These companies tend to attract income-oriented investors, who prefer a steady stream of income.
Low DPR
The lower dividend payout ratio means that the company is reinvesting more money back to expanding its business and for new products. With the investment in business growth, the business will likely generate higher levels of returns for its investors in the near future. So, these companies attract growth investors who are more interested in potential profits other than the dividend incomes.
Interpretation of Dividend Payout Ratio
The dividend payout ratio most importantly depends upon the company’s maturity level. For example, a new growth-oriented start-up business that the aims to expand their business, develop new products, and move they’re into new growing markets, it may be obvious that they reinvested the whole profits in their business with even zero dividend payout ratio and that is even better for the business.
On the other hand, a company with huge cash in its balance sheet and generating huge profit over and over the year, but there is no growth opportunity and expansion opportunity for that business, then the company may pay 70-80% of its profit as dividends.
Those mature companies have no other option than paying high dividends to their shareholders. So future price appreciation of their stock is quite difficult and generates fewer returns.
Summery
- The dividend payout ratio (DPR) is the percentage of dividends paid to the investors comparing to a company’s net income.
- There is no optimal dividend payout ratio (DPR), as DPR of a company depends heavily upon the industry, its business nature, and the maturity and business expansion plan of the company.
- High growth companies generally report a lower dividend payout ratio as profits are reinvested into the company for its growth and expansion.
- Lower growth mature companies, with no expansion plan and less growth opportunity in the market usually report a higher dividend payout ratio.
- Income-oriented value investors generally look for companies with high dividend payout ratios to invest in.
Conclusion
The dividend payout ratio is not used to measure a company, whether it is good or bad for investment. Rather, DPR is used to help investors identify how much return the company is offering the investors along with the stock’s growth. By looking at the company’s historical dividend payout ratio, it helps investors to determine, whether or not the company’s return is good match for the investor’s portfolio, risk, and future investment goals.
