Payout Ratio

AAA

DEFINITION of 'Payout Ratio'

The proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. The payout ratio can also be expressed as dividends paid out as a proportion of cash flow. The payout ratio is a key financial metric used to determine the sustainability of a company’s dividend payments. A lower payout ratio is generally preferable to a higher payout ratio, with a ratio greater than 100% indicating the company is paying out more in dividends than it makes in net income.

The Payout Ratio is calculated as follows:

Payout Ratio = Dividends per Share (DPS) / Earnings per Share (EPS)

Also known as dividend payout ratio.

INVESTOPEDIA EXPLAINS 'Payout Ratio'

For example, Company X with earnings per share of $1 and dividends per share of $0.60 has a payout ratio of 60%. Company Y with earnings per share of $2 and dividends per share of $1.50 has a payout ratio of 75%. Which company has the more sustainable payout ratio?

It really depends, since there is no single number that defines an appropriate payout ratio. The adequacy of the payout ratio depends very much on the sector. Companies in defensive industries – such as utilities, pipelines, and telecommunications – have stable and predictable earnings and cash flows, and thus can support much higher payouts than cyclical companies. Companies in cyclical sectors like resources and energy typically have lower payouts since their earnings fluctuate considerably in line with the economic cycle.

In the previous example, if Company X is a commodity producer and Company Y is a regulated utility, Y’s dividend sustainability may be better than that of X, even though X has a lower absolute payout ratio than Y.

Many companies set a target range for their payout ratios, and define them as a percentage of sustainable earnings, or cash flow. The companies with the best long-term record of dividend payments have stable payout ratios over many years. While many blue-chip companies increase their dividends year after year, since they have steady earnings growth as well, their payout ratios remain remarkably stable over extended periods.    

VIDEO

RELATED TERMS
  1. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  2. Retention Ratio

    The proportion of earnings kept back in the business as retained ...
  3. Dividend

    1. A distribution of a portion of a company's earnings, decided ...
  4. Payout

    The expected financial return from an investment over a given ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Current Dividend Preference

    A safety feature of preferred shares, whereby holders of such ...
Related Articles
  1. The Power Of Dividend Growth
    Investing Basics

    The Power Of Dividend Growth

  2. How And Why Do Companies Pay Dividends?
    Investing Basics

    How And Why Do Companies Pay Dividends?

  3. Looking Deeper Into Capital Allocation ...
    Investing Basics

    Looking Deeper Into Capital Allocation ...

  4. Why Dividends Matter
    Fundamental Analysis

    Why Dividends Matter

comments powered by Disqus
Hot Definitions
  1. Correlation

    In the world of finance, a statistical measure of how two securities move in relation to each other. Correlations are used ...
  2. Letter Of Credit

    A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. ...
  3. Due Diligence - DD

    1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to ...
  4. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate ...
  5. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors an idea of how long it takes a company to turn its inventory ...
  6. Accounts Payable - AP

    An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable ...
Trading Center