What It Is:
Total Annual Dividends Per Share / Diluted Earnings Per Share
For example, let's assume that Company XYZ distributed four regular quarterly dividend payments of $0.25 each, for a total annual dividend payment of $1.00 per share. Over the same period, XYZ reported net earnings of $10 per share.
In other words, Company XYZ distributed 10% of its net income as dividends last year and retained the remaining 90% for other operating needs.
Why It Matters:
For income-oriented investors, the dividend payout ratio is a closely-watched financial measure. Dividend payout ratios provide valuable insight into a company's dividend policy and can also reveal whether those payments appear "safe" or are in jeopardy of possibly being reduced. In the example of XYZ above, a ratio of 10% means that shareholders are only receiving a dime for every dollar the company is earning.
On the other hand, an excessively high payout ratio suggests that the company might be paying out more than it can comfortably afford. Not only does this leave just a small percentage of profits to plow back into the business, but it also leaves the firm highly susceptible to a decline in future dividend payments. In some cases, a company will even pay out more than it earns, thus yielding a dividend payout ratio in excess of 100%.
It should be noted, also, that dividend payout ratios can be impacted by a number of factors. For example, different accounting methods yield different earnings per share figures, which in turn influence the ratio.
When comparing dividend payout ratios, you should also remember that they will vary widely according to industry. For example, where many high-tech sectors often distribute small or non-existent dividends, banks and utilities typically pay out a healthy chunk of their gains each year.
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