Dividend Payout Ratio: Definition

The dividend payout ratio shows what portion of available profits is distributed away to equity shareholders in the form of dividends. Hence, the dividend payout ratio also indicates what portion of profits is being reinvested in the business.

Formula For Dividend Payout Ratio

The dividend payout ratio is the ratio of total dividends to net profit after tax. The formula is given below.

Dividend Payout Ratio Formula

To express the dividend payout ratio as a percentage, use the following formula:

Dividend Payout Ratio Formula In Percentage Terms

Example

The net profit after tax of a trading company is $240,000. During the year, the company declared and paid a dividend of $75,000. What is the company’s dividend payout ratio?

Dividend payout ratio = ($75,000/$240,000) × 100
= 0.3125 (or 31.25%)

The company paid 31.25% of its profit to shareholders in the form of dividends and retained 68.75% profit in the business for growth.

A company in its initial stages of development might find it necessary to retain a larger part of the profit in the business to help it grow. By contrast, a company with adequate liquid resources may distribute a larger portion of its profits to shareholders.

Local rules and regulations, particularly those imposed on listed companies by stock exchanges, also require companies to distribute adequate dividends to keep the interest of the shareholders alive.

Dividend Payout Ratio

Frequently Asked Questions

What is the difference between the dividend payout ratio and dividend yield?

The dividend yield is a measure of the dividends per share relative to the current share price. The dividend payout ratio shows what proportion of profits is being paid out as dividends.

What purpose does the dividend payout ratio serve?

While high dividend payout ratios show that a company is profitable, they also suggest that it may not be investing enough of its profits into the business to create additional value. A high dividend payout ratio can indicate limited growth opportunities for the company.

What are the maximum and minimum acceptable levels of dividend payout ratios?

Theoretically, there is no limit to how much a company can pay out as dividends. However, the minimum level required for dividend payment varies from industry to industry and also depends on local rules and regulations. Companies listed on stock exchanges are often required by these stock exchanges to maintain certain levels of dividend payout ratios.

What is the relationship between dividend payout ratio and corporate growth?

Companies that pay out greater portions of their profits as dividends may not be able to reinvest in the business and grow. Instead, they might distribute a larger proportion of cash back to shareholders or even borrow to finance growth initiatives while paying dividends.

What factors determine the dividend payout ratio?

The size of the business (profits), market conditions (whether the economy is growing or stagnant), industry dynamics (such as profitability and competitive intensity) and company-specific factors (such as its growth potential, risk profile, cash position, pricing power and capital requirements) all influence the dividend payout ratio.

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