Dividend Payout Ratio Meaning, Formula and Calculation

What is Dividend Payout Ratio?

The dividend payout is the percentage of the total dividend that a company pays out from its net income to the shareholders. In other words, it is the portion of the earnings distributed to the shareholder in the form of dividends. The portion that is not distributable to shareholders is utilized to either repay part of the outstanding loan or use it to fund the business’s key functions. The dividend payout ratio is sometimes labeled or simply called the payout ratio.

Understanding the Meaning of Dividend Payout Ratio

Before delving into the concept of dividend payout ratio, it is important to understand the meaning. The dividend payout ratio is a measure of the extent to which a company's profits are distributed to its shareholders in the form of dividends. A company that has a 0% ratio will not pay out dividends. On the other hand, when a ratio of 100% applies, it means the company distributes all its earnings to its owners.

In the case of a new fast-growing company, it is quite common for such firms to reinvest all their earnings into growth and new projects. So a low or zero payout ratio is expected.

On the other hand, for an already established company paying out little dividends, the investors could get annoyed and therefore there could be pressure to increase the payout.

How to Calculate Dividend Payout Ratio?

The Dividend Payout Ratio is a measure used to see what portion of a company's earnings is being paid out to shareholders in the form of dividends. It is useful for understanding how much of a company's profit is distributed versus how much is retained for reinvestment or other purposes. Use the brokerage calculator to estimate the impact of dividend payouts on your overall investment returns.

Let us understand the calculation of the dividend payout ratio with an example:

The Dividend Payout Ratio (DPR) measures how much of a company's earnings are paid out as dividends to shareholders. It can be calculated in different ways:

Basic DPR Calculation:

Formula: DPR = Dividends Paid / Net Earnings

Example: Company ABC paid ₹ 10 lakhs in dividends and earned ₹1 crore in net income. So, DPR = 10, 00,000 / 1, 00, 00,000 = 10%.

Per-Share DPR Calculation:

Formula: DPR = DPS / EPS, where DPS is Dividend Per Share and EPS is Earnings Per Share.

Example: Company XYZ paid ₹4 per share in dividends. With net earnings of ₹20 lakh and ₹2 lakh shares, the Earnings Per Share (EPS) is ₹10 (20, 00,000 / 2, 00,000). So, DPR = 4 / 10 = 40%.

DPR Based on Retention Ratio:

Formula: DPR = 1 – Retention Ratio

Example: Company DEF earned ₹50 lakhs and retained 70% of it. This means it paid out 30% as dividends. So, DPR = 1 – 0.7 = 0.3, or 30%.

Dividend Sustainability

The payout ratio helps us understand whether the dividend payments of a company are sustainable. The companies in general refrain from cutting dividends as this may decrease their stock price and reflect poorly on the management. If a company’s payout ratio is over 100%, it indicates that they are paying out more in dividends than they earned, which could be a reason for the company to cut or stop dividends in the future because it is not sustainable.

Even if a company has a bad year, it might still keep paying dividends because shareholders expect the same. Not paying dividends to shareholders will impact the company’s credibility. 

Investors do not like it when companies pay less in dividends than they usually expect, hence, stock prices usually drop if dividends are cut. It is also important to look at long-term trends in the payout ratio.  If the payout ratio is gradually increasing, it might show that the company is doing well and growing. However, if the ratio suddenly jumps, it could mean that paying the dividend is becoming too risky. 

The retention ratio is the opposite of the dividend payout ratio. While the payout ratio shows how much of a company’s profits are paid out as dividends, the retention ratio shows how much of the profits are kept or reinvested in the company.

Dividends are Industry Specific

Dividend payouts can vary a lot between different industries, and they are usually most useful when you compare companies within the same field. For instance, real estate investment trusts (REITs) must distribute at least 90% of their earnings to shareholders to benefit from certain tax advantages. However, remember, dividends are one way companies can share their profits with shareholders. 

To get more clarity on how a company returns value, you might look at the augmented payout ratio. This considers both dividends and share buybacks by dividing the total of these payouts by the company’s net income. If this ratio is very high, it might suggest the company is focusing more on boosting its stock price in the short term rather than investing in its long-term growth. 

Dividend Payout Ratio vs Dividend Yield

Through the examination of both of these components, the fact that the–dividend yield–is a measure of the simple rate of return in cash dividends paid to shareholders, while the dividend payout ratio is part of the company's net earnings that is distributed in the form of dividends. 

The Dividend Yield is calculated as:

Dividend Yield = Annual Dividends Per Share/Price per Share

In a situation where a company distributes dividends of ₹10 yearly via its stock whose price is ₹100, the yield of dividends is 10%. You may also observe that increasing the share price will decrease the dividend ratio, and on the contrary, a price fall will increase it. 

Interpretation of Dividend Payout Ratio

The dividend payout ratio (DPR) helps investors choose companies that match their goals. When you invest in a company, you make money in two ways: through dividends and by the value of your shares going up.

Here is how DPR works:

High DPR: If a company has a high DPR, it means it is paying out more of its earnings as dividends and keeping less to reinvest in the business. Investors who want regular income from dividends are drawn to these companies.

Low DPR: If a company has a low DPR, it is pumping more money back into growing the business. This can lead to a higher share price in the future. Investors who are looking for growth and bigger gains from their shares are more interested in such companies.