The dividend payout ratio is the relationship between the total amount of dividends paid to shareholders and the company's net income. To interpret the dividend payout ratio, several considerations must be taken into account, the most important of which is the degree of maturity of the company. Let's see how we can use the dividend payout ratio to our advantage.
What is the dividend distribution ratio
The dividend payout ratio is the relationship between the total amount of dividends paid to shareholders and the company's net income. It is the percentage of profits paid to shareholders via dividends. The amount not paid to shareholders is retained by the company to repay debt or reinvest in core operations. Sometimes it is simply called the distribution ratio. In turn, it is a key financial measure used to determine the sustainability of a company's dividend payment program. It is the amount of dividends paid to shareholders in relation to a company's total net income.
Coca-Cola dividend payout ratios. Source: SeekingAlpha.
What is the dividend distribution ratio for?
To interpret the dividend payout ratio, several considerations must be taken into account, the most important of which is the degree of maturity of the company. A new, growth-oriented company that aims to expand, develop new products and enter new markets should reinvest most or all of its profits and could be forgiven for a low or even zero payout ratio. The distribution ratio is 0% for companies that do not pay dividends and 100% for those that distribute all of their net income in the form of dividends. On the other hand, an old, established company returning a pittance to shareholders would test investors' patience and could tempt activists to intervene. Because it implies that a company has passed its initial growth stage, a high payout ratio means that share prices are unlikely to appreciate quickly.
Dividend payout ratio formula
The dividend payout ratio can be calculated as the annual dividend per share divided by earnings per share (EPS), or equivalently, dividends divided by net income (1). The dividend distribution ratio can also be calculated in an alternative way (2), where the retention coefficient (3) can be expressed in the way we indicate in the image.
The different formulas for calculating the dividend distribution ratio.
Example of use of the dividend distribution ratio
Companies that make a profit at the end of a fiscal year can do several things with the profits made. They can pay it out to shareholders in the form of dividends, they can retain it to reinvest in the growth of their business, or they can do both. The part of the profit that a company decides to pay to its shareholders can be measured with the distribution ratio. For example, Coca-Cola (NYSE:KO) paid $0,42 per share in dividends each quarter during 2021 (TTM). Coca-Cola's EPS during the TTM has been as follows: Q1 2021: $0,55 Q2 2021: $0,68 Q3 2021: $0,65 Q4 2021: $0,45 Apple's quarterly earnings per share is $2,33 as of February 10, 2022. Therefore, its payout ratio is 72% or $1,68 divided by $2,33.