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. Current Dividend Preference

    A safety feature of preferred shares, whereby holders of such ...
  6. Ex-Distribution

    A security or investment that is trading without the rights to ...
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. Dividend Payout Ratio
    Investing

    Dividend Payout Ratio

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

    Looking Deeper Into Capital Allocation ...

comments powered by Disqus
Hot Definitions
  1. Ghosting

    An illegal practice whereby two or more market makers collectively attempt to influence and change the price of a stock. ...
  2. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  3. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  4. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  5. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  6. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
Trading Center