Dividend Payout Ratio: a passive investing tool

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Dividend Payout Ratio In a nutshell

Everything you need to know about Dividend Payout Ratio. This is the simplest way I thought of explaining it to people new to investing or people shy from numbers.

What it is

 

dividend yield formula

Alternatively, you can also compute for this by:

 

dividend payout ratio

Meaning

Dividend payout ratio doesn´t only tell you how much percent of income is paid out by management as dividends. The number that comes from this formula also tells you if the dividend or payout given to you includes a dilution of your invested capital. If Payout is more than 1 or 100%, dividends paid out exceeds income generated by the company. As an example, if dividend Payout of a stock is 104.2% or 1.04, this means management pays 4.2 cents of the portion of your share price back.

There are various reasons for a dividend payout ratio higher than total earnings for the year. One prominent reason is that the company is chosing to give you back a portion of your invested capital since they might not need it for making further investments. While this may seem cool to the common Joe, you might want to consider why the company has no prospects momentarily to expand.. It might well be that the business model matured and the management is unable to make other use of capital. It can also indicate ineffective management and other underlying company issues.

Application

This indicator is specially watched by investors as a part of their investment portfolio.

Investors appreciate dividends but keep a careful eye that they are not giving back too much because the company´s further growth prospects have reached a bottleneck. This is achieved with a quick check of the Dividend Payout Ratio of the industry the stock is engaged in. Additionally, you will instantly know if the company is diluting their equity (your share value!) if there are bigger dividends given out than what they earned for the period.

A Simple Practical Example

As an investor of Roxy Corporation, you´d want to check if Roxy Corporation is a company that has more income or growth potential. This is achieved not only by checking if income is growing consistently but also by a quick glance on the Payout Ratio.

Information related to Roxy´s dividend payout percentage is as follows:

 

Roxy Corporation

Current price per share: $ 55.58

Dividends in a year: $ 3.64 per sh

Earnings per share (EPS) this year: $ 3.14 per sh

Dividend Payout Ratio: 1.159 or 115.9% (3.64/3.14)

 

Management paid investors this year thier share of earnings out. In addition, investors got 15.9 cents for every share held as capital dilution. You as an investor should be keen to examine underlying factors for managements decision to return excess capital that can otherwise be used for business growth and expansion.

Apart from Dividend Payout Ratio, there are other indicators that enable investors to quickly gauge a company Dividend Yield Ratio for a better and more objective examination.

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