The part of the earnings not paid to investors is left for investment to provide for future earnings growth. Investors seeking high current income and limited capital growth prefer companies with high Dividend payout ratio. However investors seeking capital growth may prefer lower payout ratio because capital gains are taxed at a lower rate. High growth firms in early life generally have low or zero payout ratios. As they mature, they tend to return more of the earnings back to investors. Note that dividend payout ratio is a recipocate ratio to dividend cover, which is calculated as EPS/DPS.
The dividend yield is given by
Some companies chose stock buybacks as an alternative to dividends, in such cases this ratio becomes less meaningful. One way to adapt it using an augmented payout ratio:
Augmented Payout Ratio = (Dividends + Buybacks)/ Net Income for the same period
The data for S&P 500 is taken from . The payout rate has gradually declined form 90% of operating earnings in 1940s to about 30% in recent years.
|Decade||Price %||Dividend||Total||Dividends as %||Average|
|Change||Contribution||Return||of Total Return||Payout|
For smaller growth companies, the average payout ratio can be as low as 10%