Dividend payout ratio

What is dividend payout ratio ?

Dividend payout ratio is a ratio that gives the proportion of net income that is paid to shareholders as reward / return for their shareholding in the company. It is basically a percentage of net income that is distributed to the shareholders as dividend payment during a given year.

It is a basic measure of gauging a company’s dividend paying ability over a specific time period.

The balance of net income remaining after payment of dividend is known as Retained earnings.

The Retention ratio can be calculate as follows:

Retention ratio = 1 – Dividend payout ratio

How do you calculate dividend payout ratio ?

The dividend payout ratio is calculated using the following formula

Dividend payout ratio = Dividend paid / Net Income

Dividend payout ratio = Dividend per share / Earnings per share

Dividend payout ratio = 1 –  Retention ratio

 

Example :

Cash Rich Co. has reported a Net Income of $ 50,000 for the year 2020. The total amount of dividend declared and paid for the year is $ 15,000. Calculate the dividend payout ratio.

Solution :

Based on the information provided in the question we have

Dividends paid for the year 2020 = $ 15,000   ;  Net Income for the year 2020 = $ 50,000    ;

 

Thus the Dividend Payout Ratio for the year 2020 shall be

= $ 15,000 / $ 50,000  = 0.30 = 30 %

The dividend payout ratio for the year 2020 = 30 % or 0.30

What does a high dividend payout ratio imply ?

A high dividend payout ratio implies that the company is well established and is maintaining a stable rate of growth. It believes in paying a major share of its net income of a given year as dividends to its owners i.e, shareholders.

The company is able to provide a steady stream of dividend payment to its shareholders. This will reflect in the form of a higher market price of the share. Companies like General motors, British petroleum, that are in existence for a long period of time typically have a high dividend payout ratio.

Companies with a high dividend payout ratio are able to raise funds easily than those with a low payout ratio, owing to an investor’s confidence of being assured a steady dividend.

What does a low dividend payout ratio imply ?

A company with a low dividend payout ratio believes in investing their net income in one or more future growth prospects of the company. It may also use the net income to repay its existing debt obligations. A low dividend payout ratio is a common feature of a growth oriented start up. Dividend payout ratio of such companies in the initial years of its existence is zero.

What does a negative dividend payout ratio mean ?

When a company pays dividends in a year in which it is making losses, it will have a negative dividend payout ratio. In this scenario, the company uses its existing cash balance or raises funds from external sources to pay dividends thereby resulting in a negative dividend payout ratio.

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