What is a Dividend Payout Ratio?
The primary motto of a company is to maximize the wealthMaximize the shareholder’s wealthWealth maximization means the maximization of the shareholder’s wealth as a result of an increase in share price thereby increasing the market capitalization of the company. The share price increase is a direct function of how competitive the company is, its positioning, growth strategy, and how it generates profits.read more So first, the company takes the money from the shareholders to finance its ongoing projects/operations. Then when these projects/operations make a profit, it becomes a duty and obligation for the company to share the profits with its shareholders. The amount of profit the company shares with the shareholders during a particular period is called a “dividend.” And the percentage of the dividend that the company pays (out of the income they make) it’s called the “dividend payout ratio.”
Dividend Payout Ratio Formula
Formula #1
First, we will discuss the most usual one and then explain the other two to expand on the concept.
The dividend ratio is the percentage of net income paid to the shareholders as a dividend in simple terms.
To practically apply this ratio, you need to go to the company’s income statement, look at the “net income,” and find out if there are any “dividend payments.”
Formula #2
As mentioned above, the dividend is one portion of the profit. Another portion that the company keeps for reinvesting into the company’s expansion is called retained earnings. And when we Calculate the percentage of retained earnings out of net income, we would get a retention ratio.
Retention Ratio = Retained Earnings / Net Income
So, in simple terms,
Dividend Payout Ratio Formula = 1 – (Retained Earnings / Net Income)
Or, Dividend Ratio = (Net Income – Retained Earnings)/Net Income
If you know the Net Income and Retained Earnings, you would easily be able to find out the dividend ratio of the company (if any). Just deduct the retained earnings from the net income and divide the figure by net income.
Formula #3
This formula is useful when you don’t have immediate access to the income statement of the company, and you only have DPS and EPSEPSEarnings Per Share (EPS) is a key financial metric that investors use to assess a company’s performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more. Simply divide DPS by EPS, and you would get the dividend ratio.
If you know the dividends and earnings, there is no way you should use this formula. But if you want to know the “per share” basis, here’s what you should do. First, divide the dividend by the number of shares, getting DPS. Then divide the net income by the number of shares, and you would get EPS.
Most people use the first formula. But in cases where you can’t access the income statement, alternative methods can be used.
Also, have a look at the Dividend Yield RatioDividend Yield RatioDividend yield ratio is the ratio of a company’s current dividend to its current share price. It represents the potential return on investment for a given stock.read more.
Dividend Payout Ratio Interpretation
Dividend Payout Ratio Example
Example # 1
Let’s look at the Income Statement of ABC Company for the year 2015 and 2016 –
It is also reported that the dividend payment for the year 2016 was the US $50,000 and for the year 2015 was US $40,000.
Perform Dividend Ratio Analysis
First of all, there are two things to consider here.
First, dividend payment for the year would not come in the Income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more of the company. As dividend payment is not an expense, it should not reduce the earnings by any means.
Second, how much dividend was paid for the year would be taken into account in the financing section of the cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more. So if you want to find the ratio in the usual way, you need to have access to both income statements and cash flow statements.
Now, let’s calculate the dividend payout ratio by using the usual ratio.
If we compare the dividend ratio for both years, we would see that in 2016, the dividend payout is more than the previous year. Depending on where the company stands in the level of maturity as a business, we would interpret it. If ABC Company is beyond the initial stages of development, this is a healthy sign.
In the next example, we will see an extension of the previous example. But the computation method of the dividend payout ratio would be different.
Example # 2
Let’s look at the Income Statement and Balance Sheet of ABC Company for the year 2015 and 2016 –
Balance Sheet Balance Sheet A balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read moreof ABC Company
Note: It is assumed that all the earnings (except the retained earnings) are paid out in the form of the dividend is both the years.
In this example, we need to calculate the dividend payout ratio where we don’t know exactly how much dividend is given.
We will follow the alternative formula of ascertaining dividend payout ratio –
Or, Dividend Payout Ratio Formula = (Net Income – Retained Earnings)/Net Income
Example # 3
MNC Company has distributed a dividend of US $20 per share in the year 2016. The earning per share for MNC in the same year is US $250 per share. Calculate the Dividend Payout Ratio of MNC companies.
In this case, we would use this alternative formula –
Apple Dividend Analysis
Let’s look at a practical example to understand the dividend ratio better –
source: ycharts
Till 2011, Apple didn’t pay any dividends to its investors. Because they believed that if they reinvested the earnings, they would be able to generate better returns for the investors, which they eventually did.
Why Exxon’s Dividends Ratio is Increasing?
Let us now perform a Dividend Ratio Analysis of Exxon. First, we note that Exxon’s Dividend Payout ratio has been increasing since 2015. Why is that so? Is the company doing great and hence, increasing its Dividends disproportionately?
There could be various reasons for the increase. 1) Increase in Dividends 2) Decrease in Net Income 3) Both 1 and 2
# 1 – Increase in Dividends
Below is the trend in Exxon’s Dividends –
We note from above that Exxon’s dividend outflow has increased from $8.02 billion in 2010 to $12.45 billion in 2016.
# 2 – Decrease in Net Income
Let us now have a look at the trend in the Net Income of Exxon.
We note that Exxon’s Income decreased by 82.5%, from $44.88 billion in 2012 to $7.84 billion in 2016. This decrease is substantial and has led to the jump in Dividends Payout Ratio.
We can conclude that Exxon’s Dividend Ratio increased due to both the Increase in Dividends Paid as well as the decrease in Net Income.
Global Banks – Stable Dividend Ratio Analysis
Global banks are large market capitalization banks that are mature and growing at a stable growth rate. In addition, we note that such banks have an optimal Dividend Ratio. Below is the list of Global Banks, along with their Market CapitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more and Payout Ratio.
- JPMorgan Chase, with Market Capitalization of $312 billion, has a payout ratio of 34.3%Citigroup has the lowest Payout Ratio at 15.3% in the above groupHSBC Holding here is an outlier with a Dividends Payout Ratio of 369.4%
Internet Companies – No Dividend Payout
Most of the Tech Companies do not give any Dividends as they have greater reinvestmentReinvestmentReinvestment is the process of investing the returns received from investment in dividends, interests, or cash rewards to purchase additional shares and reinvesting the gains. Investors do not opt for cash benefits as they are reinvesting their profits in their portfolio.read more potential as compared to mature Global Banks. Below is the list of Top Internet-based companies along with their Market Capitalization and Payout Ratio.
Despite having a large market cap, Alphabet, Facebook and others do not intend to pay any dividends. Instead, they believe that they can reinvest profits and generate higher returns for the shareholders.
Oil & Gas E&P – Negative Dividends Ratio
The negative dividends ratio happened when the company paid dividends even when the company made a loss. This is certainly not a healthy sign as the company will have to use the existing cash or raise further capital to pay dividends to the shareholders.
Below is the list of Oil & Gas Exploration & Production companies that are facing a similar situation.
Limitations
The dividend ratio always doesn’t clarify the investors about the company. There are a couple of things that can be called disadvantages. Let’s have a look at them –
- First of all, dividend payments are not always similar every year. It depends on many highly volatile factors. And dividend payment also changes with the available investment opportunities.In the investment world, investors want quick fruits. Their desire for instant gratification results in a lower valuation of a company if the company is unable to pay dividends to its investors.
Conclusion
It can be said that dividend payout ratio is a good indicator of how a company is doing in terms of its earnings, considering few factors like volatility in the market, in which stage of the business cycleBusiness CycleThe business cycle refers to the alternating phases of economic growth and decline.read more the company is in, the need for reinvestment because of expansion of the organization, how a company is being perceived in the stock market and so on. So as an investor, you need to have a holistic view of the company instead of judging the company based on the dividend payout ratio.
Dividend Payout Ratio Video Tutorial
Recommended Articles
This has been a guide to the Dividend Payout Ratio and its meaning. Here we discuss the interpretation of the dividend payout ratio and practical examples. You may learn more about financing from the following articles –
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