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What is Dividend Payout Ratio?
Stockholders invest in the company to get a fair return on theirinvestments. Before making a decision to invest in a particular company, theygenerally conduct an analysis of different company’s in an industry. One of theanalysis parts is the dividend pay ratio, upon which investor makes aninvestments by purchasing the common stock of the company.
This ratio lets the investors as well as other stakeholders in the companyto know the portion or percentage of current year’s earnings per common stockbeing paid out in the form of dividends to common stockholders.Dividend payout ratio is measured as follows:
How to calculate Dividend Payout Ratio?
Dividend payout Ratio = DividendPer common share/ Diluted earnings per share
Earnings per share are diluted in the formula becausethis is the most conservative view point.
Investors Point of View:
Investors seeking high current income and limited capital growth prefer those companies with high dividend ratio, while the investors seeking capital growth prefer low dividend ratio because capital gains are taxed at lower rates. For example if the dividend payout ratio 53.5 % then investors can expect the company to pay 53.5 cent for every 1 $ earned by company and reinvest the remaining 47.5 cent. But a problem exists; investors may assume that dividend payout implies that earnings per share represent cash, while under accrual accounting earnings per share do not necessarily represent cash pool.
Significance of Dividend Payout Ratio:
Dividend payout ratio is important for companies as well as for the investors. Investors have different preferences regarding investments. Some investors prefer to get the return on periodic basis while others want appreciation in their stocks wealth. A company with higher payout ratio might be attractive for those who want to get returns on periodic basis, but will not be suitable for those demanding appreciation in their stock wealth as the company would be investing less after paying higher dividends. But, normally a company with higher payout ratio is preferred by the investors. Dividend payout ratio is an information source for stockholders because stock with high payout ratio is considered income oriented.
There are some boundaries of dividend payout ratio. It should be noted that dividends are notpaid from earnings; in fact they are paid from cash. While the dividend payoutratio compares dividend to earnings, not to cash. So, a company may not be ableto pay dividend, if it has not sufficient cash even it has high level of earnings.