A company's dividend payout ratio gives investors an idea of how much money it returns to its shareholders compared to how much it keeps on hand to reinvest in growth, pay off debt, or add to cash reserves. This ratio is easily calculated using the figures found at the bottom of a company's income statement. It differs from the dividend yield, which compares the dividend payment to the company's current stock price.
Calculating the Dividend Payout Ratio
The dividend payout ratio is commonly calculated on a total basis using the following formula:
DPR=NIDPwhere:DP=Dividends paidNI=Net income
Another way to calculate the dividend payout ratio is on a per share basis. In this case, the formula used is dividends per share divided by earnings per share (EPS). EPS represents net income minus preferred stock dividends divided by the average number of outstanding shares over a given time period. One other variation preferred by some analysts uses the diluted net income per share that additionally factors in options on the company's stock.
Where to Find Dividend Payout Ratio Numbers
The figures for net income, EPS, and diluted EPS are all found at the bottom of a company's income statement. For the amount of dividends paid, look at the company's dividend announcement or its balance sheet, which shows outstanding shares and retained earnings.
In order to calculate the number of dividends paid from the balance sheet, use the following formula:
DP=(NI+RE)−REclosewhere:DP=Retained earnings at the beginning of the reporting periodREclose=Retained earnings at the end of the reporting period
Dividend Payout Ratio vs. Retention Ratio
The dividend payout ratio is the opposite of the retention ratio which shows the percentage of net income retained by a company after dividend payments. The payout ratio indicates the percentage of total net income paid out in the form of dividends.
Calculating the retention ratio is simple, by subtracting the dividend payout ratio from the number one.
The two ratios are essentially two sides of the same coin, providing different perspectives for analysis. A growth investor interested in a company's expansion prospects is more likely to look at the retention ratio, while an income investor more focused on analyzing dividends tends to use the dividend payout ratio.
For example, a company pays out $100 million in dividends per year and made $300 million in net income the same year. In this case, the dividend payout ratio is 33% ($100 million ÷ $300 million). Thus, the company pays out 33% of its earnings via dividends. Meanwhile, its retention ratio is 66%, or 1 minus the dividend payout ratio (1 - 33%). Thus, the company retains 66% of its net income for reinvesting.
Dividend Payout Ratio vs. Dividend Yield
While many investors are focused on the dividend yield, a high yield might not necessarily be a good thing. If a company is paying out the majority, or over 100%, of its earnings via dividends, then that dividend yield might not be sustainable.
For example, a company offers an 8% dividend yield, paying out $4 per share in dividends, but it generates just $3 per share in earnings. That means the company pays out 133% of its earnings via dividends, which is unsustainable over the long-term and may lead to a dividend cut.