In finance, the dividend pay out ratio is a system for measuring the portion of a company's revenues that is paid to its investors in the form of dividends rather than being reinvested in the company over a given period of time (usually one year, defined period. "exercise"). Usually, firms with higher payout ratios tend to be more mature: more stable companies that have already developed significantly, while those with lower payout ratios are usually younger and have high potential growth margins. To calculate the dividend pay out ratio of a certain firm over a given period of time, either the formula can be used dividends paid / net profit than that annual dividends per share / earnings per share - are both equivalent formulas.
Steps
Method 1 of 3: Net Income and Dividends
Step 1. Determine the firm's net income
First of all, to calculate the dividend pay out ratio of a firm it is necessary to determine its net income produced over the period of time considered (note that the calendar year is the period typically considered). This information is found in the company balance sheet. To be clear, look for the operating result after subtracting all costs, including taxes, business costs, write-downs, depreciation, and financial charges.
For example, imagine that Jim's new Light Bulbs company grossed $ 200,000 in its first year of operation, but incurred total costs of $ 50,000. In this case the net income of Jim's Light Bulbs would be equal to 200,000 - 50,000 = 150.000 $.
Step 2. Identify the dividends paid
At this point it is necessary to find the amount that the company in this period under consideration has paid in the form of dividends. Dividends are payments that are made to the company's shareholders, rather than being saved or reinvested in the company. Dividends are usually not highlighted in the tax return, but are described in the financial statements in the supplementary note and in the cash flow statement (if the company publishes it).
Let's assume that Jim's Light Bulbs, being a fairly young company, has decided to reinvest a large part of its profits by expanding its production capacity and paying only $ 3,750 in dividends per quarter. In this case we will have 4 × 3.750 = 15.000 $ of dividends paid in the first year of activity.
Step 3. Divide dividends by net income
Once you have determined the net income a company produces and the dividends it has paid over a given period of time, calculating the dividend pay out ratio is quite easy. All you have to do is divide the dividends paid by the net income - the result is the dividend pay out ratio.
So for Jim's Light Bulbs we can calculate the dividend pay out ratio by dividing 15,000 / 150,000 = 0, 10 (or 10%). This means that Jim's Bulbs paid their investors 10% of their profits and invested the rest (90%) in the company.
Method 2 of 3: Annual Dividends and Earnings per Share
Step 1. Calculate the dividend per share
The method described above is not the only one to calculate the dividend pay out ratio of a company - it can also be determined with two other financial quantities. To apply this alternative system, we start by looking for the dividend per share (or DPS, from the Anglo-Saxon acronym from Dividends Per Share). This represents the amount of money each investor receives for each share owned. This information is usually contained in quarterly reports, so just add the data for the four quarters to find the figure on an annual basis.
Let's look at another example. The old and well-established company I Tappeti di Rita does not have much room for growth in its current target market, therefore, rather than using its earnings to expand, it prefers to pay its shareholders generously. Suppose that in the first quarter I Tappeti di Rita paid $ 1 dividend per share, in the second quarter $ 0.75, in the third quarter $ 1.50, and in the fourth quarter $ 1.75. Wanting to calculate the dividend pay out ratio for the entire year, we will have to consider 1 + 0.75 + 1.50 + 1.75 = $ 4 per share like our DPS (dividends per share).
Step 2. Determine Earnings Per Share
It is then necessary to determine the company's earnings per share (EPS, from the English acronym Earnings Per Share). EPS represents the sum of the net profit divided by the number of shares owned by the shareholders, or in other words the amount of money that each shareholder could collect if the company hypothetically distributed dividends to them with 100% of the net profits. This type of information is usually contained in the company's financial statements.
Let's imagine that I Tappeti di Rita has 100,000 shares owned by its shareholders and that in the last fiscal year it produced $ 800,000 in profits. In this case, his EPS would have been 800,000 / 100,000 = $ 8 per share.
Step 3. Divide the annual dividend per share by the earnings per share
As with the method described at the beginning, all that remains to be done is to divide the two obtained values. The company's dividend pay out ratio is calculated by dividing dividends per share by earnings per share.
For I Tappeti di Rita the dividend pay out ratio can be calculated with the division 4/8 = 0, 50 (or 50%). In other words, the company paid its shareholders half of its profit in the form of dividends last year.
Method 3 of 3: Using the Dividend Pay Out Ratio
Step 1. Record particular one-time dividends
To tell the truth, the dividend pay out ratio only takes into account the dividends paid to shareholders on a regular basis. However, some companies sometimes pay one-off dividends to all (or even some) of their shareholders. In order to calculate the pay out ratio as accurately as possible, this type of "special" dividend should not be considered in the calculation. Following this logic, in the periods in which the payment of extraordinary dividends occurs, the formula for calculating the dividend pay out ratio must be modified as follows: (Total dividends - Extraordinary dividends) / Net profit.
For example, if a company regularly pays dividends for an annual total of $ 1,000,000 every quarter, but following an extraordinary financial income it decided to also pay an extraordinary dividend of $ 400,000, we would still have to neglect this extraordinary dividend in the calculation of the pay out ratio. Assuming a net profit of $ 3,000,000, the firm's dividend pay out ratio would be (1,400,000 - 400,000) / 3,000,000 = 0.44 (or 33.4%).
Step 2. Use the dividend pay out ratio to compare different investments
A system that people who have the money to invest adopt to compare different investment opportunities is to check the dividend pay out ratios that the different options have recorded over time. Investors usually consider the size of this ratio (in other words whether the company pays out much or little of its earnings to its shareholders), as well as its stability (i.e. how much the ratio has changed from one year to the next). to the other). Different dividend pay out ratios attract investors with different objectives, but usually both very high and very low pay out ratios (as well as very volatile ones or those that tend to decrease over time) show high risk investments.
Step 3. Choose high ratios for stable income and low ratios for high growth potential
As suggested earlier, there are compelling reasons why both high and low payout ratios can attract an investor. For those looking for a safe investment in order to obtain a stable income, the high pay out ratios may indicate that the company has grown to such an extent that it no longer needs to make further massive investments, thus constituting a safe investment. On the other hand, for those looking for a speculative opportunity in the hope of making big gains in the long run, low payout ratios could indicate that the company is investing heavily in its future. If the company ultimately achieves the desired success, the investment will prove very profitable, but it could also be risky, as the long-term potential of the company is always unknown.
Step 4. Beware of very high dividend pay out ratios
A company that distributes 100% or more of its profits as dividends might seem like a good investment, but in fact this is often read as a sign that the company's financial strength is not the best and suffers from instability. A pay out ratio of 100% or greater means that the firm is paying out more to its members than it is earning - in other words, it is losing money by paying its members. This could be a signal for a drastic reduction in the pay out ratio in the near future, as this practice is almost never sustainable.
However, there are exceptions to this trend. Established companies with high growth potential for the future can sometimes happily have a dividend pay out ratio of more than 100%. For example, in 2011, AT&T (a large US telephone company) paid a dividend of approximately $ 1.75 per share despite producing an earnings per share of only $ 0.77 - a payout ratio of over 200%.. However, due to the fact that estimated earnings per share for 2012 and 2013 were well above $ 2 per share, the short-term unsustainability of the dividend pay out ratio did not destabilize the long-term financial forecast. of the company
Warnings
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The pay out ratio should not be confused with the dividend yield, which is calculated as follows:
- Dividend yield = DPS (dividend per share) / market price of the share;
- It can also be calculated as (pay out ratio x EPS) / market price.
