Dividend Payout Ratio

Reviewed by Sweta | Updated on Aug 27, 2020

Introduction

The dividend payout ratio refers to the ratio of the aggregate dividend payments to the net income of the dividend-paying company. The dividend payout ratio is the percentage of a company’s earnings paid to the shareholders. The ratio is indicative of the earning retention for expansion. A company retains the balance earnings for business expansion.

Understanding Dividend Payout Ratio

  • A dividend payout ratio is a proportion of a company’s earnings that is paid to the shareholders. The ratio can range anywhere from zero to a hundred. In case a company does not pay any dividend due to losses, the dividend payout ratio is zero. In case a company pays the entire net income as a dividend, the ratio is hundred.
  • In general, companies payout a portion of their earnings to shareholders and retain the balance in their reserves. A growing reserve enhances the equity base of a company boosting its capability to raise debt. The retention ratio indicates the earnings retained by a company or transferred to reserves.
  • A company that is matured generally pays a steady dividend each year. In contrast, a company which is yet to break-even or make profits, such a company will not pay any dividend to the shareholder. Also, a higher retention ratio may indicate the growth-oriented nature of a company which wishes to invest in expansion.
  • Analysts, market experts and investors calculate the payout ratio and retention ratio to determine the nature of the company and its policies. The ratios could be usefully analysed over a long period to determine the growth of a company and the return to shareholders. The analysis may also indicate the strength of the balance sheet of a company and its liquidity position.

Conclusion

A dividend payout ratio may be different for different industry and companies. Certain industries are steady and can pay a steady dividend year on year. While other industries may face high leverage such as aviation or telecom industry reducing their capability to pay a dividend. Besides, there are other methods through which a company can return wealth to its shareholders such as a buyback of shares or bonus shares.