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.
Generally, a company that is matured pays a steady dividend each year. In contrast, a company which is yet to break-even or make profits 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.
