Definition | Explanation | What is "Good" | Formula | Calculation | Examples | Pros & Cons | Top 7 Tips
In other words, the DPR measures the portion or percentage of net income that is distributed to ordinary common shareholders in the form of dividends, compared to the retained earnings a company keeps on hand to:
For example, a dividend payout ratio of 40% means that a company distributed 40% of its earnings to shareholders in the form of a dividend and channelled the remaining 60% of its net income into further developing the business.
When a company generates a profit, it can do one of two things:
It then follows that a shareholder is rewarded for investing into a company’s equity in two ways:
Here’s where the DPR comes in, helping companies and investors to reconcile dividends and business growth according to their preferences:
Of course, a business can only continue paying and increasing its dividend if it is generating sufficient income to support it.
So, while a high DPR may look attractive at first glance, a dividend cut would leave investors with a lower dividend yield, along with a capital loss.
As a result, it is critical to figure out if a company is paying out a reasonable portion of earnings in dividends so that the level can be comfortably sustained–or even raised–over time.
And the DPR is one of the most popular metrics used to evaluate both the size and safety of a stock’s dividend:
| Low/High DPR: Explanation & Meaning | ||
|---|---|---|
| DPR | High | Low |
| Company Priority | Return profits back to shareholders as the owners of the business. | Reinvest net income back into the business for growth. |
| Investor Priority | Maximize short-term dividend income. | Higher potential for long-term capital growth and appreciation in stock value. Dividend safety and sustainability. |
| Disadvantages | Higher risk of unsustainable dividends. Limited growth prospects for the company and its dividends. | Lower dividend income, at least in the short-term. |
Investors who understand the DPR can make better decisions, avoid unnecessary risks, and improve the quality of their portfolios.
However, many investors do not know how to analyse the payout ratio properly. For example >>>
Did you know?
Keep reading this comprehensive guide to find out more, starting with DPR formula and calculation examples >>>
The dividend payout ratio can be calculated in 3 different ways:
All three formulas arrive at the same answer.
| Dividend Payout Ratio (DPR) Formula: 3 Methods of Calculation | |
|---|---|
| DPR Calculation Method | DPR Formula |
| Overall total share basis | DPR = Dividend Payout (DP) ÷ Net income (NI) |
| Individual per-share basis | DPR = Dividends per Share (DPS) ÷ Earnings per Share (EPS) |
| Retention ratio opposite | DPR = 1 – Retention Ratio (RR) |
Dividend Payout Ratio (DPR) = Dividends (DP) ÷ Net income (NI)
Where:
Alternatively, there are other ways in which a company can return value to its shareholders apart from distributing dividends on ordinary common stock, such as buying back shares and paying out dividends to preferred stockholders.
Hence, DPR variations can be calculated, including:
Another variation of the dividend payout ratio is calculated on a per-share basis.
Dividend Payout Ratio (DPR) = Dividends per Share (DPS) ÷ Earnings per Share (EPS)
Where:
Annualized DPS can be used as an alternative (= most recently observed dividend * previously observed frequency of dividend payments)
EPS represents net income minus preferred stock dividends divided by the average number of outstanding shares over a given time period.
One other variation preferred by some analysts uses the diluted net income per share that additionally factors in options on the company’s stock.
Earnings per share are diluted in the formula because this is the most conservative view point.
Dividend Payout Ratio (DPR) = 1 – Retention Ratio (RR)
Where:
RR is the opposite of the DPR:
When a company pays out some of its earnings as dividends to shareholders, the remaining portion is retained by the business.
Let’s take a look at three simple examples:
| DPR vs. RR Example: Dividend Payout Ratio vs. Retention Ratio | |||
|---|---|---|---|
| DPR | RR | Total Net Income | Explanation |
| 0% | 1 or 100% | 0% + 100% = 100% | No dividends paid out by a company over the given time period. The company has retained and reinvested 100% of earnings for growth. In other words, net income is equal to retained earnings. |
| 1 or 100% | 0% | 100% + 0% = 100% | A company paid out 100% of its net earnings in dividends to shareholders. In other words, net income is equal to dividends. |
| 0.5 or 50% | 0.5 or 50% | 50% + 50% =100% | A company paid half of its net earnings out as dividends to shareholders and retained the remaining 50% to reinvest into the business. |
The dividend payout ratio can be positive or negative. The ratio will generally be positive, but can be negative if a company decides to pay a dividend out of prior earnings in a year when a net loss is incurred.
The DPR is usually presented either as a number (e.g., “1”, “0.5”) or multiplied by 100 to arrive at a percentage (e.g., 100%, 50%).
Let’s calculate the DPS of Company A using the three different methods:
Over the past two years, Company A had 10,000 shares of common stock outstanding and generated net income of $100,000 and $500,000 at the end of each of the two years, respectively. The company declared a per-share dividend of $0.50 in Year 1 and increased it to $4.00 per share in Year 2.
| Company A Financials | Year 1 | Year 2 |
|---|---|---|
| Net Income (NI) | $100,000 | $500,000 |
| Number of Shares | 10,000 | 10,000 |
| DPS | $0.50 | $4.00 |
| Dividend Payout (DP) | $0.50 x 10,000 = $5,000 | $4 x 10,000 = $40,000 |
| Total DPR = DP ÷ NI | $5,000 ÷ $100,000 = 5% | $40,000 ÷ $500,000 = 8% |
| EPS | $100,000 ÷ 10,000 = $10 | $500,000 ÷ 10,000 = $50 |
| Per-share DPR = DPS ÷ EPS | $0.50 ÷ $10 = 5% | $4 ÷ $50 = 8% |
| %-based Retention Ratio (RR) = 1 – DPR | 100% – 5% = 95% | 100% – 8% = 92% |
| NI-based RR = Retained Earnings ÷ NI | $100,000 - $5,000 = $95,000 | $500,000 - $40,000 = $460,000 |
| Per-share RR = (EPS−DPS) ÷ EPS | $10 - $0.5 = $9.50 | $50 - $4 = $46 |
| Retention DPR = 1 - RR | $100,000 - $95,000 = $5,000 | $500,000 - $460,000 = $40,000 |
| 100% - 95% = 5% | 100% - 92% = 8% | |
| $10 - $9.5 = $0.50 | $50 - $46 = $4 |
The DPS of Company A was 0.05 or 5% in Year 1 and increased to 0.08 or 8% in Year 2.
A zero or low ratio means that a company is either using all of its net income to grow its business or does not actually have any earnings to distribute.
On the other side of the spectrum, a DPR over 100% means a company is paying out more in dividends than the cash it is taking in. Companies sometimes do this to keep shareholders happy even if they hit a rough patch.
However, it is certainly not a sustainable long-term strategy because the company may be:
Therefore, rather than a high DPR, investors typically prefer a healthy DPR–usually between 30%-60%–that provides a good dividend, while at the same time making it more sustainable for the business to growth–and the dividends with it–even if earnings go through a temporary slump.
| What is Good Dividend Payout Ratio (DPR)? | |
|---|---|
| DPR | Interpretation |
| <0% | Loss-making |
| 0% | No Dividend |
| 0% - 35% | Low |
| 35% - 55% | Good |
| 55% - 75% | High |
| 75% - 95% | Very High |
| 95% - 150% | Unsustainable |
| >150% | Highly Unsustainable |
| What is Good Dividend Payout Ratio (DPR)? - Explanation | ||
|---|---|---|
| DPR | Explanation | |
| <0% | Loss-making: If a company with DPR<0% is expected to continue operating at a loss, then the dividend payout is not likely to continue going forward. | |
| 0% | No Dividend: DPR of 0% means that a company dos not pay any dividends. | |
| 0% - 35% | Low: A ratio ranging up to 35% is generally regarded as a lower payout, mostly associated with “value investing” (i.e., investors focus on stock value appreciation) as opposed to “income investing” (i.e., invest focus on income from stock dividends). | |
| 35% - 55% | Good: A range of 35% to 55% is considered healthy from both the value and income investment point of view because the company is distributing approximately half of its income as dividends, while at the same time retaining and reinvesting the other half of its earnings into additional income producing assets. | |
| 55% - 75% | High: DPR between 55% to 75% is viewed as high because it implies that a company distributes more than half of its earnings as dividends. While this is welcome from dividend investors’ perspective, the lower level of retained earnings may limit the company’s ability to grow–and distribute dividends–in the future. Hence, a DPR target of 50% to 60% is typically the sweet spot for dividend investors looking for companies that have a healthy mix of earnings retention and dividends. | |
| 75% - 95% | Very High: A payout ratio between 75% to 95% is deemed to be rather high, implying that a company declares most of the money it makes as dividends. This increases the risk of the company cutting its dividends in the future. So, while a very high dividend may be attractive in the short-term, it may not last in the long-term. | |
| 95% - 150% | Unsustainable: DPR equal to 100% means that a company pays out its entire net income in dividends to shareholders. If DPR exceeds 100%, a company distributes more money in dividends than it earns, which is not a sustainable long-term strategy that may result in any future dividends being cut or even eliminated. | |
| >150% | Highly Unsustainable: If the payout ratio exceeds 150%, it is even more likely that the dividends may not be sustainable in the future. | |
As you can see, a high/low DPR ratio is not necessarily good or bad.
There is no magic ideal DPR number.
The optimal dividend payout ratio will always depend on many factors, including:
Keep reading to find out the advantages and disadvantages of low & high DPRs, as well as the most important things you need to know before making any judgements based on the dividend payout ratio >>>
A high DPR does not always equal “good” DPR.
Rather, reporting a “good” DPR is a balancing act as both high and low ratios have their pros and cons.
| HIGH DPR: Advantages & Disadvantages | |
|---|---|
| Pros | Attracts investors focused on dividend income. |
| High monetary reward for shareholders, at least in the short-term. | |
| Cons | High dividend payouts must not be hindering business growth (e.g., taking on excessive debt or passing up on growth opportunities). |
| Dividends may be subject to fluctuation or cancellation, which could affect share price. | |
| LOW DPR: Advantages & Disadvantages | ||
|---|---|---|
| Pros | Attracts investors focused on value appreciation. | |
| Allows companies to both invest into business growth and consistently reward shareholders with stable dividends over the long-term. | ||
| Low risk of dividend cuts. | ||
| High likelihood of continuously rising dividend payout–and consequently also share price. | ||
| Cash reserves available for unforeseen difficulties. | ||
| Cons | Cash reserves must be justified and well spent to grow the business and create value. | |
Therefore, you will need to do much more due diligence to established if a DPR is “good” or “bad” for your specific purposes.
Keep reading to find out my 7 top tips on how to do just that >>>
Here are the top 7 considerations that go into interpreting the dividend payout ratio:
When assessing a company’s DPR, remember to consider its level of maturity.
Rather than paying dividends to shareholders, younger growth-oriented companies are likely to channel most-or all-of their net income toward further growth, such as:
As a result of keeping a large portion of earnings in the business to take advantage of the ample reinvestment opportunities and a high rate of return on assets, they can be expected to report a relatively low–or even zero–dividend payout ratio.
Conversely, strong and consistent dividend payout ratios are often associated with large, well-established companies that have already matured and have less room for further growth and expanding their market share through large capital expenditures.
Essentially, there is no reason for mature companies to accumulate excessive cash reserves if they cannot use the money to pursue growth opportunities–so they rather spend their surplus income on shareholder dividends.
| DPR vs. Company Maturity | ||
|---|---|---|
| DPR | High | Low |
| Maturity | Mature | Growth-oriented |
| Growth | Slow | Fast |
| Age | Established | Young |
| Size | Large | Small |
| Priorities | Less room to grow = Less need to commit high percentage of income to business expansion. | Aggressively reinvest earnings into the business for competitiveness, expansion and future growth. |
| Example | Blue chips (e.g., General Motors, Coca-Cola), Dividend Aristocrats (e.g., AT&T, Colgate-Palmolive) | Start-ups |
Similarly, companies paying higher dividends tend to be in well-established mature industries with stable earnings and little room for additional growth, where paying higher dividends may be the best use of profits.
On the other hand, sectors characterized by volatile earnings, fast pace of change, and the need to aggressively reinvest into research and growth to remain relevant and increase profits are known to declare lower dividends.
For example, high-tech industries tend to distribute little to no dividends, while companies in the utility sector generally declare a large portion of their earnings as dividends.
Also, companies in cyclical industries, such as consumer discretionary goods, may pay a lower portion of their net income as dividends to maintain their ability to pay out dividends in periods when the business is slower.
Furthermore, payout ratios can be essentially ignored for some industries, such as the REITs (real estate investment trusts) and MLPs (master limited partnerships) in the United States. US REITs and MLPs will always show high DPR because they have a unique financial structure and are required by law to pay out most of their earnings in the form of dividends.
Since DPRs vary so greatly by industry, it is most useful to benchmark them against the industry averages.
| DPR vs. Company Industry | ||
|---|---|---|
| DPR | High | Low |
| Reinvestment requirements | Less need to commit a high percentage of income to business expansion. | Need to aggressively reinvest into research and growth to remain competitive and increase profits. |
| Growth | Slow | Fast |
| Revenues | Stable | Volatile |
| Example | Utilities, telecom, consumer staples | Consumer discretionary goods, technology (e.g., Google, Amazon, Facebook, Netflix) |
Dividend sustainability is another important judgment that you can make based on the DPR analysis to assess the likelihood of a company’s earnings to sustain the payment of future dividends.
At first glance, high dividend yields look attractive. However, if a company cuts the dividend in the future, investors are left with a lower yield–as well as a capital loss.
Actually, share stocks with the highest yields can often be in a distressed financial condition.
Hence, the dividend payout ratio should not be too high, otherwise a company may become unable to maintain such levels of payouts if the earnings fall in future periods.
Also, higher dividend payments imply less money to fund business development initiatives and seize growth opportunities. Similarly, a high DPR can affect a company’s cash flow and liquidity, because dividends are paid in cash. This can hinder further growth of a company–and its future dividends.
As a general rule of thumb, you want to see a DPR under 100%. Anything above that level indicates that a company is distributing more cash to its shareholders than it is earning.
Companies can sometimes endure a certain period of declining profits without suspending dividends, and it is often in their interest to do so in order to keep the shareholders and stock markets happy.
In this case, a company can raise the funds needed to make the dividend payments through a combination of alternative methods, including:
However, this strategy is not a sustainable long-term solution. Excessive dividends could force a company to, for example:
In other words, it (literally) pays off for a company to hold on some cash.
Moreover, analyzing changes in a company’s DPR over time is more meaningful than just looking at a single ratio in isolation.
Following a stock’s dividend long-term trends provides additional insight into whether a company’s performance is growing, declining or stable–along with the level of historical safety or volatility of its dividends.
Arguably, a sustainable and consistent trend in dividend payouts and the DPR ratio is more important than a one-off high or low ratio.
Let’s say that a company has had a DPR of 20% for the last 10 years. Here, we can reasonably assume that the business will continue distributing 20% of its profit to the shareholders going forward.
Nevertheless, watch out for a dividend payout ratio that has plateaued, particularly if the company previously used to increased dividends every year. Even if the ratio is at a healthy level, the failure to continue to increase dividends over time could be a warning sign.
A payout ratio that is consistently and steadily rising over time suggests that a company has been maturing into a healthy and stable business that will continue to be able to maintain both its growth and dividends.
Conversely, a downward trend in DPR and dividend payouts may indicate deteriorating performance of a company, because there are essentially two main reasons for a fall in DPR:
As an example, when the DPR has continuously decreased for the last 3-5 years, it could mean that a company may find it difficult to maintain such a high level of dividend in the future.
If a DPR suddenly changes, it could mean one of three things:
For a cyclical business, it is normal to show spikes and dips in DPR due to seasonal changes. Year-over-year analysis is helpful here to compare the results for the same period against the prior years.
For example, if there is a sudden spike in DPR in one particular period, the company either had an especially profitable year and wants to share the success with its shareholders, or alternatively it is trying hard to incentivise investors into buying its shares.
Nevertheless, a company may be able to survive a couple of less profitable years without suspending its dividends to help maintain the confidence of its shareholders and the market in general.
In any case, the overall trend as well as any sudden changes in the dividend payout ratio should be carefully analysed.
Companies typically stubbornly avoid cutting their dividends because:
Essentially, there are three situations in which a company reports a good DPR:
Hence, the market generally views strong and sustainable dividend payout ratio positively, because it shows that a company’s management is making good financial decisions to grow revenues and manage costs, while maintaining consistent and/or improving dividend payouts.
Furthermore, high payout ratios may signal that a company is confident in its ability to generate sufficient income to distribute dividends at the same or higher levels in the future.
Conversely, there are a number of reasons why DCR of a company could decrease, including:
1. Deteriorating financials resulting in a dividend cut
2. Increasing earnings but dividends not increased at a corresponding rate
The market reaction depends on the circumstances. For example, during a recession, the market is more understanding to companies temporarily slashing dividends in the favour of conserving cash.
Nevertheless, investors generally lose confidence in companies that reduce dividends, “punishing” them by selling off shares and driving the share price further down.
Also, investors may pressure companies with large retained earnings to increase existing dividends by declaring one-time special dividends or stock buy backs.
In any case, investors expect a timely announcement and clear explanation of any changes in dividend policy, especially when dividend cuts are concerned. One of the key reasons is that dividend-paying stocks are an important fixed-income component of many individual and institutional investment portfolios.
Of course, dividend cuts are not the only change in DPR that can upset the market and reduce a company’s stock price.
Another example is when a company desperately tries to use excessive dividends to increase the attractiveness of its stock, which could mean it is in financial distress and perhaps unable to obtain financing through earnings or debt. While the unreasonably high DPR may spur the interest of some investors, most will view it as unsustainable.
Consequently, dividend cuts send a negative signal to the stock market, because they:
As a result, companies are typically extremely reluctant to reduce or eliminate their dividends, which leads to three main outcomes:
The dividend payout ratio is just one piece of the puzzle when it comes to assessing the performance of a company and its shares.
In addition to considering the factors described above, it is important to holistically assess the DPR in the context of its internal and external environment, as well as other financial and non-financial factors, including (but not limited to):
And finally, whether a dividend payout ratio is “good” or bad “depends” on the intention of the investor.
As such, the ratio helps investors determine whether a company is a good fit for their overall investment strategy–goals, portfolio and risk tolerance.
When investors purchase shares in a company, return on their investment comes from two sources:
The idea is that any net income that is not distributed to shareholders in dividends is retained and reinvested into the business to fuel earnings growth, which may generate higher levels of capital gains for investors in the future.
Consequently, the decision to invest in a company is based on the extent of an investor’s belief that the stock is likely to pay dividends and/or appreciate in share price.
The following table summarizes how the two sources of shareholder return are related to the DPR:
| DPR vs. Investor Goals | ||
|---|---|---|
| DPR | High | Low |
| Company Goal | Reinvest smaller portion of net income back into the business in favor of paying out dividends to shareholders. | Reinvest larger portion of net income back into the company to accelerate future growth of the business and capital gains for investors. |
| Investor Goal | Dividend income | Capital gains |
| Investor Preference | Steady stream of income and/or maximized dividend payments | High potential for share price appreciation |
| Investor Type | “Income Investor” aka “Dividend Investor” | “Value Investor” aka “Growth Investor” |
In summary, a high dividend payout ratio is typically more attractive to investors who purchase shares to earn regular dividend income, whereas a low DPR is more suitable for those who prioritize future appreciation in the value of common stock, i.e. a significant rise in share price.
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