Dividend Payout Ratio
Chapter Thirty-Eight
Syllabus topic 4, "Combined Ratio : i) Return on capital employed (Including Long Term Borrowings) ii) Return on proprietor's Fund (Shareholders Fund and Preference Capital) iii) Return on Equity Capital iv) Dividend Payout Ratio v) Debt Service Ratio vi) Debtors Turnover vii) Creditors Turnover (Practical Question on Ratio Analysis and Du Point Analysis)"
Pages 100 to 102 of 162
In one line
The dividend payout ratio is the proportion of the equity earnings that was paid out as dividend rather than kept in the business.
The formula
Dividend payout ratio = (Dividend per equity share / Earnings per equity share) x 100
And the same thing on totals, which gives the identical answer:
Dividend payout ratio = (Equity dividend / (Profit after tax less preference dividend)) x 100
Expressed as a percentage. There is no standard; it is a matter of policy, and the answer is read against the company's own past and against the trade.
Its complement
Retention ratio = 100 less the dividend payout ratio
The two total 100 by definition, and the retention ratio is what the company kept to finance itself. Give both; the second is often the more revealing.
Worked on Sunrise
| 2027, Rs | |
|---|---|
| Profit after tax | 2,38,000 |
| Less: preference dividend | 18,000 |
| Profit available to equity shareholders | 2,20,000 |
| 2027, Rs | |
|---|---|
| Equity dividend, 6 per cent on Rs 10,00,000 | 60,000 |
| 2027, Rs | |
|---|---|
| Earnings per share, 2,20,000 over 1,00,000 shares | 2.20 |
| Dividend per share, 60,000 over 1,00,000 shares | 0.60 |
| 2027 | |
|---|---|
| Dividend payout ratio | 27.27 per cent |
| Retention ratio | 72.73 per cent |
And the check on totals: Rs 60,000 over Rs 2,20,000 is 27.27 per cent, the same figure.
Interpretation
Sunrise paid out 27 paise of every rupee its equity shareholders earned and kept 73. That is a low payout and a high retention, and it is consistent with everything else the analysis has shown: the company financed the whole of its growth out of reserves and took no new borrowing.
Whether that is good depends on who is asking.
| Who | How they read a 27 per cent payout |
|---|---|
| A shareholder wanting income | Unfavourable; he is being paid little |
| A shareholder wanting growth | Favourable, provided the retained money earns well |
| The test that settles it | Compare the return on equity, 16.92 per cent, with what the shareholder could earn elsewhere |
Sunrise's retained profits are earning 16.92 per cent inside the business. A shareholder who could not earn that elsewhere is better off with the money retained, and the low payout is justified. That comparison is the interpretation, and an answer that gives it is complete.
What a high or low payout means
| Payout | Usually means |
|---|---|
| High, say above 60 per cent | A mature business with little to invest in; or a company under pressure to please its shareholders. Little is left to finance growth |
| Moderate | A balance between income and reinvestment |
| Low, or nil | A growing business ploughing back; or a company that cannot afford a dividend. The two look identical in this ratio and only the profit figure distinguishes them |
The last row is the caution. A nil payout by a company earning well is a growth policy; a nil payout by a company earning nothing is a symptom. Always report the earnings per share beside the payout.
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