Definition: The percentage of a corporation’s earnings (aka profits) per share that it pays to its shareholders.
Example: ABC Corporation achieves $1.00 in earnings per share in the latest quarter. Its Board of Directors declares a dividend of $.40 per share. The payout ratio is $.40 / $1.00, or 40%. To find an annual figure, we can add up the dividends paid over the last four quarters and divide it by the total earnings per share achieved over the last four quarters.
Investeach explains: Any profits not paid to shareholders are “retained” by the corporation. Profits are usually kept to allow the corporation to grow. It is so important for corporations to have ample cash on hand to take advantage of opportunities that large corporations usually pay a ratio of just 40% or less.
So-called “growth stocks” may pay no dividend at all. Some growth corporations become so successful that they earn profits at a faster rate than they can find good opportunities in which to invest it. Over the course of several years, they can accumulate $10’s of billions of dollars in cash. When these corporations’ growth rates slow, they usually begin paying a regular quarterly dividend. They may also use the cash to buy back shares of their stock and/or to pay a large one-time dividend.
Another reason why normal payout ratios are low is that it gives corporations the ability to maintain or boost dividends even if difficult economic times mean they aren’t achieving increasing profits each year. In the above example, the corporation could impress shareholders by raising its dividend to $.41, $.42, $.43, and $.44 over the next four quarters even if it continued to earn $1.00 in profit per share each quarter.
Riddle me this:
1. How is the dividend payout ratio computed?
2. What is the dividend payout ratio of a corporation which earns $1.20 per share and pays out $.40 of it as a dividend?
3. What happens to the portion of profits that is not paid out as dividends?
4. Identify two reasons why corporations like to keep the payout ratio low.
5. Identify the dividend ratio of many growth corporations.
6. Explain the options available to growth corporations which accumulate more cash over the course of several years than they can successfully reinvest.