The Dividend Payout Ratio Explained

Evaluating the dividend payout ratio lets us focus on companies that have enough internal growth to give us those dividend increases that we want each year.

As we know, these dividend increases will help our portfolio income beat inflation over time and provide us with a growing income in retirement.

How To Calculate The Payout Ratio

The dividend payout ratio is calculated by dividing the dividend paid by the net income per share.

Dividend Paid/Net Income per Share = Dividend Payout Ratio

Why The Payout Ratio Is Important

For the most part, we should be looking for stocks that have a dividend payout ratio somewhere between 40-60%. This allows a good portion of the profits to be paid to the shareholder as well as allowing for some of the profits to be plowed back into the company to create more internal growth.

The higher the dividend payout ratio, the less profits are invested back into the business to create future growth. In our dividend growth strategy, we look for companies that invest back into the business in order to create more growth that will allow for another increase in the dividend.

Can Companies Pay out More Than They Earn

As we mentioned before, dividend payout ratios of greater than 100% are possible, but very difficult to sustain and significantly hamper the growth of the business.

In tough economies temporary increases in the dividend payout ratio can be common because it can be very damaging to a stock if the company suspends or lowers the dividend.

High yields may look appealing at first, but we must ensure that the dividend is both sustainable and able to grow.

15 comments

  1. Thanks and this makes sense, but I would think that it is better to seek a payout ratio of between 30 – 40% for the sake of sustained company growth and continued future payouts.

  2. So how can a company like Verizon and AT&T have a payout ratio of 250%? They are paying out more than profits, but how can they do this and remain viable?

  3. Joanne,
    Thanks for stopping by.
    The short answer to your question is that they can’t.
    However, if they believe that the inability to cover the dividend is a short term problem, the damage that would be done to the stock price by cutting the dividend is more hazardous than covering the dividend for the short term.
    If this is a long term issue, then you will eventually see a dividned cut.

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