Dividend payout ratio

A company can do two things with its profit: pay it out to shareholders or keep it to fund the business, pay down debt or save it. The payout ratio is the share that is paid out as dividends. The rest, the retention ratio, stays in the company.

A low ratio leaves room to keep paying even if profit falls. A ratio above 100% means the company pays more than it earned that year, from savings, from asset sales or with borrowed money.

The first two give the same answer when the share count is steady. The cash version compares the dividend with the cash the business actually produced after investment, because dividends are paid in cash, not in accounting profit. Its inverse, free cash flow divided by dividends, is often called dividend coverage.

A company earned $500 million last year and paid $200 million in dividends. Its payout ratio is 200 ÷ 500 = 40%, and it kept the other 60%. Per share the arithmetic is the same: $1.60 of dividends on $4.00 of earnings per share is 40%.

Its free cash flow was $300 million. The cash payout ratio is 200 ÷ 300, about 67%, and dividend coverage is 300 ÷ 200 = 1.5. Earnings look comfortable, and the cash picture is tighter. That gap is worth a look before reading anything into the 40%.

• There is no single safe number. For a mature company a payout between roughly 30% and 60% of earnings is often described as comfortable, but it depends on the business.
• Sectors differ. Utilities and makers of everyday consumer goods, with steady earnings, often pay out more. Fast-growing companies tend to pay little or nothing and reinvest instead.
• REITs are a special case. US rules require them to distribute most of their taxable income, so their payout is usually measured against funds from operations (FFO), not net income.
• One year can mislead. A one-off loss can push the ratio far above 100% while the cash flow is fine, and a one-off gain can do the opposite. Several years and the cash version together give a better picture.

• Stable dividend: the company pays the same amount, or raises it slowly, and lets the payout ratio move with profit. Most large US companies work this way, and they are reluctant to cut.
• Constant payout ratio: the company pays a fixed share of each year's profit, so the dividend rises and falls with earnings.
• Residual dividend: the company funds its investment plans first and pays out what is left.

None of these predicts a cut on its own, and companies sometimes keep paying through them. Together they are the usual reasons a dividend gets reduced.

• The payout ratio stays above 100% for several years in a row.
• Free cash flow does not cover the dividend, so it is funded with debt or savings.
• Debt keeps rising while earnings stay flat or fall.
• Earnings are falling and the company keeps the dividend unchanged anyway.
• A very high dividend yield. It can mean the market already doubts the dividend will last, the pattern often called a dividend trap.

• For dividend-paying companies, the company page shows a dividend resilience row: steady, under pressure or high cut risk.
• It is a heuristic built on predictors from the academic literature: how well free cash flow covers the dividends paid, the payout ratio and debt.
• The payout ratio there is cash dividends paid divided by net income, from the latest annual report filed with the SEC, so it can lag by up to a year. A loss counts as the weakest case.
• It does not apply to banks, insurers or REITs, and it is not a price forecast.