Dividend Payout Ratio

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Dividend pay-out ratio – my three favourite words after, “Today is payday.”

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It tells you how much money a company is returning to its shareholders, in the form of dividends, compared to how much they earned that year.

How do you calculate the dividend pay-out ratio?

It’s simple, Simon. In fact, as you’ll see below:

Dividend Pay-out Ratio = Total Dividends / Earnings Per Share

Let’s say, for example, Awesome Company reports earnings per share to the amount of $1.20, $1.10, $1.25 and $1.15 over the last four quarters. That would amount to a total yearly earnings of $4.70 per share. Now let’s say during that same year, Awesome Company paid out $3.10 in dividends per share to its shareholders.

If we divide the total dividend of $3.10 by the total earnings of $4.70, then we get a dividend pay-out ratio of roughly 65%. (Whip out your calculator for this.) It means that Awesome Company paid out 65% of its profits as dividends in that year. That also means it kept 35% of the profits for either a lavish holiday for its employees or, more likely, to pay off debt or to invest in new innovation and growth.

How can you tell if a dividend pay-out ratio is good or bad?

This is a good question and it really depends on whether the company is just starting out or if it’s a seasoned veteran like, says General Electric, which has been around since the dawn of man.

A new start-up may have a low or even zero, dividend pay-out ratio because it’s pumping all its profits back into developing new products, buying out other companies to help it grow, or a whole host of other reasons.

However, a more established company that’s been around the block for some time can’t get away without paying any profits to its shareholders. It will be expected to share the love, so it will probably offer a higher dividend ratio to keep its investors sweet.

But if the dividend pay-out ratio is greater than 100%, that could be a red flag…

That means it’s returning more money to its shareholders than it is making. This is clearly not a good sign. It means that in time, the company could be forced to lower the dividend amount, or stop paying one altogether, until it gets profitable again.

This could spell trouble for the share price as investors take their money and run. Because they will likely prefer to park it into another company that is growing and more likely to increase its dividends over time. After all, it’s all about the money!

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