Dividend Payout Ratio 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 Dividend Payout Ratio say anything about the growth of the company? How would you compute dividend payout ratio?

In this article, we will look at the nitty-gritty of dividend payout ratio.

• What is Dividend Payout Ratio?
• Dividend Payout Ratio Formula
• Dividend Payout Ratio Interpretation
• Dividend Payout Ratio Example
  • Dividend Payout Ratio – Example # 1
  • Dividend Payout Ratio – Example # 2
  • Dividend Payout Ratio – Example # 3
• Apple – Dividend Payout Ratio
• Why Exxon’s Dividends Payout Ratio is Increasing?
• Global Banks – Stable Dividend Payout Ratio
• Internet Companies – No Dividend Payout
• Oil & Gas E&P – Negative Dividends Payout Ratio
• Limitations of Dividend Payout Ratio
• Conclusion

What is Dividend Payout Ratio?

The primary motto of a company is to maximize the wealth 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 “dividend payout ratio”.

• You may wonder – do companies pay all of the profit to shareholders? Sometimes they do. But in most cases, the companies keep a percentage of profit so that they can reinvest in their expansion. This percentage of profit is called “retained earnings”. And the act of keeping a portion of profit separately is called “plowing back of profits”.
• If we look at start-up companies, we would see that dividend is not always paid out in the initial phases. Because whatever profits the organizations generate need to reinvest into their own operations for expanding their markets and customer reach. Other than start-ups, many tech giants rarely give away dividends to their shareholders. For example, Apple was established back in the 1970s. But Apple started giving dividends in 2012 to its shareholders. Amazon, Facebook, Google haven’t yet paid a penny in dividends.
• Conversely, there are also many companies which give away dividend as if they don’t need to keep the money for operations at all. Thus, their percentage of dividend payout is unreasonably higher.
• As an investor, you should look at all the aspects of a company to decide whether to invest into the company; not only the dividend payout ratio. For companies, they need to take a balanced approach to deal with their dividend payments, because keeping the money for the expansion of operations is equally important for the perpetuity of the company.

Dividend Payout Ratio Formula

Let’s look at the dividend payout ratio formula.

Dividend Payout Ratio Formula #1

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

In simple terms, dividend payout 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 is any “dividend payments”. In the example section, we will see how to compute dividend payout ratio using this formula.

Dividend Payout Ratio Formula #2

However, this is not the only formula to calculate dividend payout ratio. Let’s have a look at the next formula of dividend payout ratio –

As mentioned above 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 compute the percentage of retained earnings out of net income, we would get retention ratio.

Retention Ratio = Retained Earnings / Net Income

So, in simple terms,

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

Or, Dividend Payout 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 pay-out ratio of the company (if any). Just deduct the retained earnings from the net income and the divide the figure by net income. And you will get the dividend payout ratio.

Dividend Payout Ratio Formula #3

But this is not it. There is another formula of dividend payout ratio which we should look into.

Here’s the formula –

This formula is useful when you don’t have an 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 payout 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 Dividend Yield Ratio

Dividend Payout Ratio Interpretation

To interpret dividend payout ratio, we need to consider few things –

• 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, 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 near future. Think of Berkshire Hathaway here.
• Maintaining Dividend Payout Each Year – There are other aspects of dividend payout ratio should also be considered. If a company has started giving dividend for few years, it should ensure that it gives away dividend 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 into 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. 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, dividend payout ratio is usually higher.

Dividend Payout Ratio Example

Let’s see few examples to analyze Dividend Payout Ratio from all angles.

Dividend Payout Ratio – Example # 1

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

Details	2016 (In US $)	2015 (In US $)
Sales	30,00,000	28,00,000
(-) Cost of Goods Sold (COGS)	(21,00,000)	(20,00,000)
Gross Profit	900,000	800,000
General Expenses	180,000	120,000
Selling Expenses	220,000	230,000
Total Operating Expenses	(400,000)	(350,000)
Operating Income	500,000	450,000
Interest expenses	(50,000)	(50,000)
Profit before Income Tax	450,000	400,000
Income Tax	(125,000)	(100,000)
Net Income	325,000	300,000

It is also reported that the dividend payment for the year 2016 was US $50,000 and for the year 2015 was US $40,000.

Perform Dividend Payout 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 statement. So if you want to find dividend pay-out ratio in the usual way, you need to have access to both income statement and cash flow statement.

Now, let’s calculate the dividend payout ratio by using the usual ratio.

Details	2016 (In US $)	2015 (In US $)
Dividend Payment (1)	50,000	40,000
Net Income (2)	325,000	300,000
Dividend Pay-out Ratio (1/2)	15.38%	13.33%

If we compare the dividend payout 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 dividend payout ratio would be different.

Dividend Payout Ratio – Example # 2

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

Details	2016 (In US $)	2015 (In US $)
Sales	30,00,000	28,00,000
(-) Cost of Goods Sold (COGS)	(21,00,000)	(20,00,000)
Gross Profit	900,000	800,000
General Expenses	180,000	120,000
Selling Expenses	220,000	230,000
Total Operating Expenses	(400,000)	(350,000)
Operating Income	500,000	450,000
Interest expenses	(50,000)	(50,000)
Profit before Income Tax	450,000	400,000
Income Tax	(125,000)	(100,000)
Net Income	325,000	300,000

Balance Sheet of ABC Company

	2016 (In US $)	2015 (In US $)
Assets
Current Assets	300,000	400,000
Investments	45,00,000	41,00,000
Plant & Machinery	13,00,000	16,00,000
Intangible Assets	15,000	10,000
Total Assets	61,15,000	61,10,000
Liabilities
Current Liabilities	200,000	2,70,000
Long term Liabilities	1,15,000	1,40,000
Total Liabilities	3,15,000	4,10,000

Stockholders’ Equity
Preferred Stock	550,000	550,000
Common Stock	50,00,000	50,00,000
Retained Earnings	250,000	150,000
Total Stockholders’ Equity	58,00,000	57,00,000
Total liabilities & Stockholders’ Equity	61,15,000	61,10,000

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

Since we made an assumption here that no earnings were paid for debt, we can compute the dividend pay-out ratio easily.

Details	2016 (In US $)	2015 (In US $)
Retained Earnings (1)	250,000	150,000
Net Income (2)	325,000	300,000
N.I. – R.E. (3 = 2 -1 )	75,000	150,000
Dividend Payout Ratio (3/2)	23.08%	50%

Let’s look at the last example. In this example, we will find the dividend payout ratio by using another alternative formula.

Dividend Payout Ratio – 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 the US $250 per share. Compute the Dividend Payout Ratio of MNC Company.

In this case, we would use this alternative formula –

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

Let’s calculate the Dividend Payout Ratio –

Details	2016 (In US $)
Dividend per share (1)	20
Earnings per share (2)	250
Dividend Pay-out Ratio (1/2)	8%

Apple – Dividend Payout Ratio Analysis

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

source: ycharts

Items	2012	2013	2014	2015	2016
Dividends ($ bn)	2.49	10.56	11.13	11.56	12.15
Net Income ($bn)	41.73	37.04	39.51	53.39	45.69
Dividends Payout Ratio	5.97%	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 Payout Ratio is Increasing?

Let us now perform Dividend Payout 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?

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 –

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 Net Income of Exxon.

source: ycharts

We note that Exxon’s Income decreased 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 Payout Ratio increased due to both the Increase in Dividends Paid as well as the decrease in Net Income.

Global Banks – Stable Dividend Payout 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 Payout Ratio. Below is the list of Global Banks along with their Market Capitalization and Dividend Payout Ratio.

S. No	Name	Market Cap ($ million)	Dividend Payout Ratio (Annual)
1	JPMorgan Chase	312895.4	34.3%
2	Wells Fargo	271054.5	41.2%
3	Bank of America	237949.9027	23.4%
4	Citigroup	177530.0	15.3%
5	HSBC Holdings	177155.6	369.4%
6	Royal Bank of Canada	103992.2	48.0%
7	Banco Santander	97118.3	37.2%
8	The Toronto-Dominion Bank	91322.0	43.2%
9	Mitsubishi UFJ Financial	88234.7	31.3%
10	Westpac Banking	78430.5	72.6%
11	Bank of Nova Scotia	71475.7	50.6%
12	ING Groep	66593.5	50.7%
13	UBS Group	60503.3	98.8%
14	BBVA	54568.5	46.0%
15	Sumitomo Mitsui Financial	54215.5	29.0%

• JPMorgan Chase with Market Capitalization of $312 billion has a dividend payout ratio of 34.3%
• Citigroup has the lowest Dividend Payout Ratio at 15.3% in the above group
• HSBC Holding here is an outlier with 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 reinvestment potential as compared to mature Global Banks. Below is the list of Top Internet-based companies along with their Market Capitalization and Dividend Payout Ratio.

S. No	Name	Market Cap ($ million)	Dividend Payout Ratio (Annual)
1	Alphabet	674,607	0.0%
2	Facebook	443,044	0.0%
3	Baidu	61,442	0.0%
4	JD.com	56,408	0.0%
5	Altaba	52,184	0.0%
6	Snap	21,083	0.0%
7	Weibo	16,306	0.0%
8	Twitter	12,468	0.0%
9	VeriSign	9,503	0.0%
10	Yandex	8,609	0.0%
11	IAC/InterActive	8,212	0.0%
12	Momo	7,433	0.0%

Despite of having 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 Payout Ratio

Negative dividends Payout 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. No	Name	Market Cap ($ million)	Dividend Payout Ratio (Annual)
1	ConocoPhillips	57,352	-34.7%
2	EOG Resources	50,840	-34.0%
3	Occidental Petroleum	47,427	-402.3%
4	Canadian Natural	34,573	-371.6%
5	Pioneer Natural Resources	27,009	-2.3%
6	Anadarko Petroleum	26,168	-3.4%
7	Apache	18,953	-27.0%
8	Devon Energy	16,465	-6.7%
9	Hess	13,657	-5.7%
10	Noble Energy	12,597	-17.2%
11	Marathon Oil	10,616	-7.6%
12	Cabot Oil & Gas	10,516	-8.7%
13	EQT	9,274	-4.4%
14	Cimarex Energy	8,888	-9.3%

Limitations of Dividend Payout Ratio

Dividend pay-out ratio always doesn’t give clarity to the investors about the company. There are 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, the 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 business cycle 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 dividend payout ratio.

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