Dividend Payout Ratio

What is a Dividend Payout Ratio?

The dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) in comparison to the net income of the company; a company paying 20 million USD dividend out of their 100 million USD net income will have a ratio of 0.2.

It is an important indicator of how a company is doing financially. As we note from above, Colgate Dividend Payout Ratio was 61.78% in 2016-17. However, Amazon, Google, and Berkshire Hathway haven’t paid a penny to the shareholders via Dividends. What does this mean? Does this ratio say anything about the growth of the company?

The primary motto of a company is to maximize the wealthMaximize The 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 of the shareholders. The company takes the money from the shareholders to finance its on-going projects/operations, and 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 “dividend.” And the percentage of the dividend that the company pays (out of the income they make), it’s called the “dividend payout ratio.”

Colgate-vs-Amazon-Dividend-payout

Dividend Payout Ratio Formula

Formula #1

First, we will talk about the most usual one and then explain the other two to expand on the concept.

In simple terms, the dividend ratio is the percentage of net income that is paid to the shareholders as a dividend.

To practically apply this ratio, you need to go to the income statement of the company, look at the “net income” and find out if there are any “dividend payments.”

Formula #2

Dividend Ratio = 1 – Retention Ratio

As mentioned above, the dividend is one portion of the profit. Another portion which the company keeps for reinvesting into the expansion of the company 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 then divide the figure by net income.

Formula #3

Dividend Payout Ratio Formula = Dividends per Share (DPS) / Earnings per Share (EPS)

This formula is useful when you don’t have immediate access to the income statement of the company, and you only have DPS and EPS. 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. Divide the dividend by the number of shares, and you would get 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 to the income statement, the 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

  • The maturity of the Organization- First of all, by dividend payout ratio, one can understand the level of maturity of an organization. For example, if an organization is growth-oriented and new in the market, the chances are that most of the profits it would reinvest into the expansion of its operations. Rarely these new, growth-oriented companies pay dividends because to be able to pay dividends, they first need to go beyond its initial stage of business. Think of Amazon here.
  • Reinvestment Opportunities – In some cases, established companies always don’t pay a lot of dividends to the shareholders. In that case, it’s really a test of shareholders’ patience as with time, they would expect more and more benefits to being returned to them. But many established companies justify their 0% payout ratio by reinvesting more and more money into the operation to ensure that the shareholders’ money gets utilized properly and generates a better return for them in the near future. Think of Berkshire Hathaway here.
  • Maintaining Dividend Ratio Each Year – There are other aspects of the dividend payout ratio that should also be considered. If a company has started giving dividends for a few years, it should ensure that it gives away dividends every year without any downward trend. Maintenance of dividend payout every year helps the company doing good in the stock market, and more and more investors get attracted to invest in the company. Think of Colgate here.
  • Upward Trend in Dividends – Every company which pays a dividend should aim to pay a higher dividend each year to the shareholders than the previous year. A long upward trend ensures that the company is financially healthy and doing great in terms of generating revenue. A higher payout of dividends is not applicable for every company, but there are exceptions. For example, REITs (Real Estate Investment Trust) are legally obligated to pay 90% of their earnings to shareholders. In the case of MLPs (Master Limited Partnership), though not mandatory, the dividend payout ratio is usually higher.

Dividend Payout Ratio Example

Example # 1

Let’s look at the Income Statement of ABC Company for the year 2015 and 2016 –

Details2016 (In US $)2015 (In US $)
Sales30,00,00028,00,000
(-) Cost of Goods SoldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more (COGS)(21,00,000)(20,00,000)
Gross Profit900,000800,000
General Expenses180,000120,000
Selling ExpensesSelling ExpensesThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.read more220,000230,000
Total Operating Expenses(400,000)(350,000)
Operating Income500,000450,000
Interest expenses(50,000)(50,000)
Profit before Income Tax450,000400,000
Income Tax(125,000)(100,000)
Net Income325,000300,000


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 statement 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 StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities.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.

Details2016 (In US $)2015 (In US $)
Dividend Payment (1)50,00040,000
Net Income (2)325,000300,000
Dividend Ratio (1/2)15.38%13.33%

If we compare the dividend ratio for both the 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 –

Details2016 (In US $)2015 (In US $)
Sales30,00,00028,00,000
(-) Cost of Goods SoldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more (COGS)(21,00,000)(20,00,000)
Gross Profit900,000800,000
General Expenses180,000120,000
Selling Expenses220,000230,000
Total Operating Expenses(400,000)(350,000)
Operating Income500,000450,000
Interest expenses(50,000)(50,000)
Profit before Income Tax450,000400,000
Income Tax(125,000)(100,000)
Net Income325,000300,000


Balance Sheet of ABC Company

2016 (In US $)2015 (In US $)
Assets  
Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more300,000400,000
Investments45,00,00041,00,000
Plant & Machinery13,00,00016,00,000
Intangible AssetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more15,00010,000
Total Assets61,15,00061,10,000
Liabilities  
Current LiabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more200,0002,70,000
Long term LiabilitiesLong Term LiabilitiesLong Term Liabilities, also known as Non-Current Liabilities, refer to a Company’s financial obligations that are due for over a year (from its operating cycle or the Balance Sheet Date). read more1,15,0001,40,000
Total Liabilities3,15,0004,10,000
Stockholders’ Equity
Preferred Stock550,000550,000
Common Stock50,00,00050,00,000
Retained Earnings250,000150,000
Total Stockholders’ Equity58,00,00057,00,000
Total liabilities & Stockholders’ Equity61,15,00061,10,000


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 –

Dividend Payout Ratio Formula = 1 – (Retained Earnings / Net Income)

Or, Dividend Payout Ratio Formula = (Net Income – Retained Earnings)/Net Income

Details2016 (In US $)2015 (In US $)
Retained EarningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more (1)250,000150,000
Net Income (2)325,000300,000
NI. – R.E. (3 = 2 -1 )75,000150,000
Dividend Ratio (3/2)23.08%50%

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 –

Details2016 (In US $)
Dividend per share (1)20
Earnings per share (2)250
Dividend Ratio (1/2)8%

Apple Dividend Analysis

Let’s look at a practical example to understand the dividend ratio better –

Apple-Dividends-Payout-Ratio

source: ycharts

Items20122013201420152016
Dividends ($ bn)2.4910.5611.1311.5612.15
Net Income ($bn)41.7337.0439.5153.3945.69
Dividends Payout Ratio5.97%28.51%28.17%21.65%26.59%

Till 2011, Apple didn’t pay any dividend to its investors. Because they believed that if they would reinvest the earnings, they would be able to generate better returns for the investors, which they did eventually.

Why Exxon’s Dividends Ratio is Increasing?

Let us now perform a Dividend Ratio Analysis of Exxon. 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?

Exxon-Dividend-Payout-Ratio-increasing

source: ycharts

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 –

Exxon-Dividend-Payout-Ratio-increasing

source: ycharts

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.

Exxon-Dividends-Payout-Decreasing-Income

source: ycharts

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. We note that such banks have an optimal Dividend Ratio. Below is the list of Global Banks along with their Market Capitalization and Payout Ratio.

S. NoNameMarket Cap ($ million)Dividend Payout Ratio (Annual)
1JPMorgan Chase312895.434.3%
2Wells Fargo271054.541.2%
3Bank of America237949.902723.4%
4Citigroup177530.015.3%
5HSBC Holdings177155.6369.4%
6Royal Bank of Canada103992.248.0%
7Banco Santander97118.337.2%
8The Toronto-Dominion Bank91322.043.2%
9Mitsubishi UFJ Financial88234.731.3%
10Westpac Banking78430.572.6%
11Bank of Nova Scotia71475.750.6%
12ING Group66593.550.7%
13UBS Group60503.398.8%
14BBVA54568.546.0%
15Sumitomo Mitsui Financial54215.529.0%
  • 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 group
  • HSBC 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.

S. NoName Market Cap ($ million)Dividend Payout Ratio (Annual)
1Alphabet   674,6070.0%
2Facebook  443,0440.0%
3Baidu  61,4420.0%
4JD.com  56,4080.0%
5Altaba  52,1840.0%
6Snap  21,0830.0%
7Weibo  16,3060.0%
8Twitter 12,4680.0%
9VeriSign 9,5030.0%
10Yandex  8,6090.0%
11IAC/InterActive 8,2120.0%
12Momo  7,4330.0%

Despite having a large market cap, Alphabet, Facebook and others do not intend to pay any dividends in the near future. They believe that they can reinvest profits and generate higher returns for the shareholders.

Oil & Gas E&P – Negative Dividends Ratio

Negative dividends Ratio happens when the company pays 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.

S. NoName Market Cap ($ million)Dividend Payout Ratio (Annual)
1ConocoPhillips  57,352-34.7%
2EOG Resources  50,840-34.0%
3Occidental Petroleum  47,427-402.3%
4Canadian Natural  34,573-371.6%
5Pioneer Natural Resources   27,009-2.3%
6Anadarko Petroleum   26,168-3.4%
7Apache  18,953-27.0%
8Devon Energy   16,465-6.7%
9Hess  13,657-5.7%
10Noble Energy  12,597-17.2%
11Marathon Oil 10,616-7.6%
12Cabot Oil & Gas 10,516-8.7%
13EQT  9,274-4.4%
14Cimarex Energy  8,888-9.3%

Limitations

The dividend ratio always doesn’t give clarity to the investors about the company. There are a couple of things that can be called as disadvantages. Let’s have a look at them –

  • First of all, dividend payments are not always similar every year. It depends on many factors which are highly volatile. 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 represents the expansion and contraction of the economy that occurs due to ups and downs in the gross domestic product (GDP) of a country. It is experienced over the long term and goes parallel with the natural growth rate.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 and so forth. So as an investor, you need to have a holistic view of the company instead of just judging the company on the basis of the dividend payout ratio.

Dividend Payout Ratio Video Tutorial

Recommended Articles

This has been a guide to what is Dividend Payout Ratio and its meaning. Here we discuss the interpretation of dividend payout ratio along with practical examples. You may learn more about financing from the following articles –

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Comments

  1. AvatarKhadir says

    Thanks for your valuable information

    • AvatarDheeraj Vaidya says

      thanks Khadir!

  2. AvatarAfolabi Segun says

    Hi Dheeraj,
    Thanks for this interesting piece.
    You make finance concepts easy to understand.
    Keep up the good work,
    Regards,

    • AvatarDheeraj Vaidya says

      thanks Afolabi!