Dividend Payout Ratio

The Dividend Payout Ratio is used to determine the percentage of earnings that are given to the shareholders in the form of dividends.

You can use one of two formulas.

(Dividends Per Share) / (Earnings Per Share) or

(Total Dividends) / (Net Income)

This looks at how the dividends are supported by its earnings. It also shows where the company is spending its money.

If the Dividend Payout ratio is too high it could work against the investor. Say the ratio is at 60% that means 60% of its earnings are going to pay its share holders. That also means 60% that could have been reinvested into making the company grow was paid out.

This could result in a lower growth rate. In this rate you will be giving up growth for dividends. That is not always bad if you want a stock that produces an income but doesn’t need to grow that much.

Someone looking to invest a large sum of money and live off of the dividends would not be as concerned by a high ratio as someone who is looking to grow their money over the long term.

Just be aware that higher ratios could mean lower growth.

Other Ratios

It is always wise to look at other financial ratios as well. Here is a small list.

Gordon Growth Model - This looks at the future growth of dividends

Debt to Capital Ratio – This looks at how much debt a company is using

Horizontal Analysis and Vertical Analysis – 2 Ways to measure a company