The payout ratio measures what share of a company's profit is paid out as dividends. It's the most direct way to tell whether a dividend is sustainable or whether the company is stretching itself too far.
How it's calculated
The payout is found by dividing dividends paid by net profit, expressed as a percentage:
- Payout ratio = Dividends ÷ Net profit × 100
If a company earns $100 million and pays $40 in dividends, its payout is 40%: it returns four of every ten dollars it earns to shareholders and reinvests the rest in the business.
What it tells you
The payout reveals the balance between paying out and reinvesting. A low payout (say, 30%) leaves the company plenty of money to grow, reduce debt or raise the dividend in the future. A high payout (80-90%) means it pays out almost everything it earns: the dividend is generous today, but there's little margin if profit falls. And a payout above 100% is unsustainable: it pays out more than it brings in.
The nuance: better with cash flow
The classic payout uses accounting profit, which can be dressed up. That's why many investors prefer to compute it on free cash flow: the dividend is paid with real cash, not an accounting entry. A dividend that fits comfortably within free cash flow is far safer than one that only adds up on paper.
How to use it well
A good dividend isn't the highest, but the safest and growing one: a moderate payout, stable profit and cash flow to spare. Always cross-check the payout with the dividend yield and the company's financial health. To see the yield, debt and cash flow of any stock, type its ticker into the analyzer.