Companies often share a portion of their earnings with shareholders through dividends. The dividend payout ratio tells investors exactly how much of a company’s income is being shared. While some companies choose to share a high percentage of their earnings with investors, others choose to share less.

This article will help explain what the dividend payout ratio is, how it’s calculated, and how you can use it to make informed investment decisions. 

The dividend payout ratio helps investors understand how much of a company’s income is paid out to its shareholders through dividends. It’s typically shown as a percentage, helping you understand what percentage of a company’s income is being distributed to investors.

While some companies distribute all their earnings to shareholders, most only pay out a portion and choose to reinvest the rest of their earnings back into the company.

While both are used to measure the potential earnings provided by investing in a specific stock, the dividend payout ratio and dividend yield measure different things.

• Dividend Yield: Dividend yield measures the income investors earn for every dollar they invest. It’s calculated by dividing the annual dividend per share by the stock’s current price.
• Dividend Payout Ratio: Dividend payout ratio measures how much of a company’s earnings are paid out to its investors. It’s calculated by dividing the total amount of dividends paid to investors by the company’s net income.

Is there an ideal payout ratio?

There’s no such thing as an ideal dividend payout ratio. A company’s dividend payout ratio depends on several things, including the industry they operate in, the nature of their business, and the company’s maturity and business model. Companies focused on growth tend to have a lower dividend payout ratio but may offer higher opportunities for growth. More mature companies tend to have higher dividend payout ratios but may be less likely to grow in the future.

What is considered a good dividend payout ratio?

A company’s dividend payout ratio can be influenced by many factors. Companies focused on growth tend to have lower dividend payout ratios than more established companies and dividend payout ratios can vary significantly across different industries. It’s also important to note that a high dividend payout ratio may not be always a good thing. If a company’s dividend payout ratio is too high, it’s unlikely to be sustainable and may be a sign that a company is in financial trouble.

What is more important, dividend rate or dividend yield? 

The dividend rate tells you how much you’ll earn for every share you own, whereas the dividend yield tells you how much you’ll earn relative to the stock’s current price. Understanding how earnings provided by a given stock compare to the stock’s price gives you a better idea of the potential return on your investment.

How to analyze the dividend payout ratio?

While the dividend payout ratio is an important metric, you should never look at it alone. It's important to consider a range of financial metrics when making investment decisions, including a company’s dividend payout ratio, dividend yield, earnings per share, cash flow, etc., and how those metrics have changed over time.  

Do dividend payout ratios vary by sector?

Yes, dividend payout ratios can vary significantly by sector. High dividend payout ratios can limit a company’s growth. Sectors that prioritize growth, such as the technology sector, tend to have lower dividend payout ratios. Sectors with high earnings and consistent cash flows, such as the telecommunications and utilities sector, tend to have higher dividend payout ratios. It's always best to compare dividend payout ratios of companies within the same industry or sector.

The dividend payout ratio helps investors understand how much of a company’s income is paid out to investors. Some companies share a significant percentage of their income with shareholders while other companies share very little. High dividend payout ratios may not be always good, and low dividend payout ratios may not be always bad. It’s just one of many metrics that investors can use to assess the value of investing in a particular stock.

Understanding dividend payout ratios and how to compare them can help you make informed investment decisions and reach your financial goals sooner.