What percentage of a company’s income goes to its shareholders? This is the question at the heart of the dividend payout ratio, which measures what investors can expect to receive in dividends. Keep reading to learn how to calculate dividend payout ratio and what this figure means for your investment.
What is a dividend payout ratio (DPR)?
The payout ratio compares dividends paid out to shareholders to the company’s total net income. When a company generates income, it must decide how to use this positive cash flow. Some will be kept in company accounts to boost cash reserves and pay off outstanding debt. A company might also use the money to reinvest in new projects and facilitate growth.
The remainder of the net income will be paid out in dividends to shareholders, and this percentage is what the dividend payout ratio measures. Payout ratio is separate to dividend yield, which compares the current stock price to dividend payment.
How to calculate dividend payout ratio
You’ll have your pick of several formulas to calculate payout ratio. Here are the two most common formulas used:
Total Dividends / Net Income
Dividends per Share / Earnings per Share
To get started with calculating the payout ratio using any of these formulas, you can use an early payout calculator or look at the company’s income statement. This shows the net income, earnings per share, and diluted earnings per share. To find the dividend payout, you’ll need to look at the company’s balance sheet to find retained earnings as well as outstanding shares.
Payout ratio example
We can put these formulas to work with a couple of examples.
Example 1: Company XYZ reports a net income of £25,000 for the tax year on its balance sheet. During the same tax year, it issues £5,000 to its shareholders in dividends. You can calculate dividend payout ratio by dividing the total dividends by net income:
£5,000 / £25,000 = 20%
This shows that Company XYZ is paying 20% of its net income to its shareholders, while the remaining 80% is set aside as retained earnings. These might be reinvested or used to pay off company debt.
Example 2: Company ABC declares a payment of £0.50 dividend per share to its shareholders. Its declared earnings per share was £3.25 for the most recent fiscal year. You can use the second formula, dividing dividends per share by earnings per share, to calculate the payout ratio:
£0.50 / £3.25 = 0.1538 or 15.4%
In this case, the payout ratio is 15.4% paid in dividends, and the remaining 84.6% retained as earnings.
What does payout ratio tell you?
Whether you use an early payout calculator, or the formulas listed above, what does this ratio really mean for investors? It can be a handy comparison tool for investors to find companies that best meet their financial goals. Here’s what dividend payout means for you:
Companies with a high DPR are paying out more in earnings to shareholders, which means they are retaining less to reinvest into the company. If you’re an investor looking for a steady income stream, this might be a good option. However, retaining fewer earnings could mean less chance for growth.
Companies with a low DPR are focusing more on reinvestment. This means there is greater chance for capital gains in the future as the company grows, but in the short term view the dividend income stream will be more limited.
There’s no right or wrong answer for investors, so it’s important to think about whether you’re more interested in a long or short-term payout. Learning to calculate dividend payout ratio can be helpful in assessing company potential as you compare all options carefully.
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