Dividend Payout Ratio

Dividend payout ratio measures the proportion of earnings attributable to common stock which is distributed out as cash dividends. It is calculated by dividing common share dividends by the net income attributable to common shareholders.

Dividend payout ratio is reciprocal of retention ratio (or plow-back ratio) which measures the percentage of earnings a company reinvests in projects to generate future growth.

Since a company's stock performance depends heavily on its ability to pay sustained dividends, dividend payout ratio is a very important indicator of a company's stock performance. Because companies attempt to not change dividend payments drastically but their earnings attributable to common stock-holders fluctuate a lot, conclusions regarding dividend policy should be reached after analyzing multiple periods.

Formula

Dividend payout ratio can be calculated using the following formula:

Dividend Payout Ratio =Common Dividends Paid=Dividend per Share
Net Income Attributable to Common StockEarnings per Share

Net income attributable to common stock equals net income minus preferred dividends i.e. dividends paid on preferred stock.

Dividend per share (DPS) and earnings per share (EPS) equal total common stock dividends and total earnings respectively divided by weighted-average number of shares of common stock.

Dividend payout ratio includes cash dividends but no stock dividends.

Interpretation

People invest in a company expecting a return on their investment which comes from two sources: capital gains and dividends. The return from these two sources is inter-related. A high dividend payout ratio means that the company is reinvesting less earnings in future projects, which in turn means less capital gains in future periods. Similarly, low payout ratio today may result in higher capital gains in future.

Some investors prefer companies which provide high potential for capital gains while others prefer companies that pay high dividends. Dividend payout ratio helps each class of investors identify which companies to invest in.

Dividend payout ratio also provides an indication of a company’s future growth potential. For investors which are interested in high growth companies, a consistent high dividend payout ratio may not be a good sign.

Dividend payout ratio should be analyzed in the context of industry and other ratios such as dividend yield ratio, price to earnings ratio, etc.

A more meaningful dividend analysis would also include any share buyback by a company. A share buyback is a way of returning cash to investors which involves purchase of own shares by companies. Such share buybacks increase share price of the company, which in turn results in capital gains for the shareholders.

Ratio of expected dividend per share to expected earnings per share attributable to common stock is called forward dividend payout ratio. Forward dividend payout ratio divided by the difference between required return on common stock and expected dividend growth rate equals forward or justified price to earnings ratio.

Example

Based on the information given below, calculate and analyze dividend payout ratio for Apple, Inc. and ExxonMobil Corp.

All amounts are USD in million.

2011201220132014
Apple (NYSE: AAPL)
Dividends-2,48810,56411,126
Net income25,92241,73337,03739,510
Cash and investments25,95229,12940,59025,158
ExxonMobil (NYSE:XOM)
Dividends9,02010,09210,87511,568
Net income41,06044,88032,58032,520
Cash and investments12,6649,5824,6444,616

Solution

Dividend Payout Ratio for AAPL for 2012 =$2,488= 5.96%
$41,733

The table below shows dividend payout ratios for AAPL and XOM from 2011 till 2014.

Industry2011201220132014
AAPLTechnology05.96%28.52%28.16%
XOMOil and Gas21.97%22.49%33.38%35.57%

Apple, Inc. did not pay any dividends in 2011 because the management believed that a higher return for investors can be achieved if the earnings generated are reinvested in projects that will generate future growth. This is supported by the company’s exceptional revenue growth in 2012. However, during the period from 2012 till 2014 the company’s cash pile was way above the level needed to avail the feasible new projects, so the management paid generous dividends in these years. However, in case of a technology company, high dividend payouts are an exception and not a rule.

ExxonMobil Corp. on the other hand is in a mature industry. Hence, it is expected to maintain a steadily rising dividend payout. Since any drop in payout ratio has very adverse effect on stock price, XOM has kept its dividend payout ratio in the range of 23-36% in the four years which is pretty stable.

by Obaidullah Jan, ACA, CFA and last modified on

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