Dividend Payout Ratio: Meaning, Formula and Analysis

What is Dividend Payout Ratio?

Dividend payout ratio means ratio in between the amount paid by company as dividend to its shareholders and amount company generates in the form of total net income earned. It is simply the percentage of net income distributed by company to its shareholders during year. Every company function with prime motive of enhancing the overall wealth of its shareholders as these are the people who finance all of its on-going project/operations.

Therefore, it become duty of company to share their profits with shareholders. Amount of profit which company shares with its shareholders is termed as Dividend and proportion in which company shares this profit amount is what we call “Dividend Payout ratio”. 

All investors are keenly interested in knowing the dividend payout ratio of companies for knowing if companies are paying reasonable part of income to investors or not. They consider dividend payout ratio as a key parameter while deciding the investment decisions. Therefore, companies must decide on adequate dividend payout ratio in order to attract investors and enjoy sufficient amount of funds.

Formula for calculation of Dividend Payout Ratio

Dividend Payout Ratio is computed using the following formula: –

      Dividend Payout Ratio (DPR)= Dividend per share/ Earnings per share

Numerator in above formula represents the dividend per share paid out to common shareholders and excludes any dividend payments to preferred shareholders.

Another formula used for DPR computation is by dividing the total dividend amount paid on common stock by total earnings available for common stockholders during that specific period.

Dividend Payout Ratio= Total amount of dividend for period/ Net amount of income available for common stockholders

Analysis of Dividend Payout Ratio

Dividend payout ratio is an adequate means for analyzing whether company has sufficient funds for supporting their dividend payments at ongoing rate. It may seem that a company with higher DPR is better than one having lower DPR. But this may not always be true, what really matters is consistency with which the company is paying out dividends. A company with consistent and stable dividend payout ratio of 15% is more trustworthy than company having payout ratio of 20% but is not stable and is continuously on decline over the years. May be the higher dividend paying company will not be able to pay any dividend in coming years due to its non-consistency. Instead of relying heavily on dividend rate, more focus should be made on long-term trends or consistency.

It should also be noted that start-up companies initially want to expand their business activities and therefore retain a large part of their profit for business growth. They have due to this reason lower dividend payout ratio but start giving higher ratio when don’t have sufficient projects to invest.

Therefore, for an investor who is looking for steady dividend income option, it is must to consider the long-term trends and performance records of company with respect to their dividend paying. Investors need to be more aware and attentive about companies paying higher amount of dividend as they are paying majority part of their earning as dividend and relying only on little part for future activities investment that is not a good sign.