Dividend Payout Ratio (DPR)

Dividend Payout Ratio

Definition:

The dividend payout ratio measures the percentage of a company's net income that is returned to shareholders in the form of dividends. (In the United Kingdom, this concept of Dividend Payout is referred to as Dividend Cover)

It is used as a tool in Analysis of Financial Statements. The payout ratio provides an idea of how well earnings support the dividend payments. More mature companies tend to have a higher payout ratio. When applied correctly, dividend payout ratios can be a powerful analytical tool.

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Calculation of dividend payout ratio:

DPR=

Dividend Per Share

Earnings Per Share

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For example, if XYZ company paid out $2 per share in annual dividends and had $4 in EPS, the DPR would be 50%. ($2 / $4 = 50%)

Growing companies will typically retain more profits to fund growth and pay lower or no dividends. So the Dividend Payout Ratio will be lower as the company expect that retaining the earnings, the return to shareholders can be maximised. Dividend payout ratios provide valuable insight into a company's dividend policy and can also reveal whether those payments appear "safe" or are in jeopardy of possibly being reduced. In the example of XYZ above, a ratio of 50% means that shareholders are only receiving 50 cents for every dollar the company is earning. In this case, the company is generating ample profits to support this relatively modest payment. In fact, if management considered it in the best interests of the company, it could probably afford to raise its dividend payment significantly.
Companies that pay higher dividends may be in mature industries where there is little room for growth and investment, so paying higher dividends is the best use of profits in such cases. An excessively high payout ratio suggests that the company might be paying out more than it can comfortably afford. Not only does this leave just a small percentage of profits to plow back into the business, but it also leaves the firm highly susceptible to a decline in future dividend payments. In some cases, a company will even pay out more than it earns, thus yielding a dividend payout ratio in excess of 100%. Such extremely high payouts are rarely sustainable and should warn investors that a dividend cut may be on the horizon. Because the act of reducing dividends is usually interpreted as a sign of weakness, when a dividend cut announcement is made, it also usually triggers a decline in the share price. Even if management finds a way to maintain an extremely high dividend payout ratio for an extended period of time, this strategy usually results in either a dwindling cash position or a rising debt load.

Dividend payout ratios can be impacted by a number of factors. For example, different accounting methods yield different earnings per share figures, which in turn influence the ratio. Furthermore, businesses in different growth stages can be expected to have different dividend policies. Young, fast-growing companies are typically focused on reinvesting earnings in order to grow the business. As such, they generally sport low (or even zero) dividend payout ratios. At the same time, larger, more-established companies can usually afford to return a larger percentage of earnings to stockholders.

Note: It can be misleading to compare the ratios of companies operating in different industries.