In plain English
The payout ratio shows how much of each dollar of profit goes to shareholders.
Payout ratio = dividends per share ÷ earnings per share × 100
Example
A company earns $4 per share and pays a $2 dividend. The payout ratio is 50%: half of its profit is paid out and half is kept for the business.
Why it matters
A very high ratio leaves little cushion. If profits dip, the dividend may have to be cut. A very low ratio can mean room to grow the dividend. What counts as “high” depends on the industry: REITs and utilities usually pay out more than technology companies.
Some analysts use free cash flow instead of earnings, because dividends are paid in cash.
Common mistakes
- Using a single year. Look at the trend over several years.
- Ignoring one-off profits or losses that distort earnings.