Money Matters

Is a High Dividend Payout Ratio Better?

Dividend payout ratios: what high and low values mean for companies and investors, and the pros and cons of both.

What Is Dividend Payout Ratio?

The dividend payout ratio (DPR) is the value of dividend payments in relation to company profit. When companies generate income, they distribute a percentage to shareholders. 

👉 The dividend payout ratio is calculated by dividing the total dollar amount of dividends a company is going to distribute by the net income the company generates over that period.

These values are publicly disclosed to investors in many ways, including through the release of various financial statements. Simplistically, this can be understood as the percentage of earnings a company pays out to investors as dividends. 

Let’s take a look at a few examples to explain this process better:

The CFO of SleepCo, a new bedding company, is attempting to calculate their dividend payout ratio for their balance sheet.

  • He is told that the total income the company accumulated over the last quarter was roughly $30,000.
  • In addition, the company has informed him that they distributed $6,000 to shareholders through dividends.
  • Therefore, their dividend stocks account for about 20% of the company's total income, as $6,000/$30,000=.2 or 20%. 

Now, the CFO wants to interpret what this dividend payout ratio entails. In order to do so, he begins to research what effects lower/higher dividend payout ratios have and what they tell him about the company. 

After some careful consideration, he determines that:

High DPR

What does a high DPR mean?

A high dividend payout ratio means that the company spends a large portion of its profits in the form of dividends, rather than reinvesting them back into the business. This may be particularly enticing to income investors who are seeking high dividend yields.

Which companies have high DPRs?

Companies with high dividend payout ratios are typically more mature and have accumulated enough profit to look past expansionary spending and shift their focus outwardly to entice as many income investors as possible. Typically, very well-established companies will offer high dividend payout ratios, which is why blue-chip companies can be seen as intelligent income investments. 

What values are considered high DPRs?

There is no concrete value that is considered “high dividend payment ratio” but many investors agree that anything above roughly 23% is a relatively high value. Again, this means that a company distributes >23% of its profits towards dividend payments.

Low DPR

What does a low DPR mean?

Lower dividend payout ratios, by definition, are the antithesis of high dividend payout ratios. Companies offering low dividend payout ratios are most likely in the expansionary stage of their business cycle. 

In essence, these companies tend to allocate a smaller percentage of their income to dividend payments because they need to use the funds to continue expanding their brand/clientele. 

Which companies have low DPRs?

These companies tend to be less mature or established. Eventually, they may aim to increase their dividend payout ratios as profits begin to increase. Until then, it is likely that much of their incomes are instead being used for advertising, brand promotion, or other expansionary tactics. 

What values are considered low DPRs?

Typically, dividend payout ratios that are lower than about 14% are considered low by the general public. Some companies will offer anywhere from 1-10% in their primitive stages of public trading; these companies would be at the very bottom of the spectrum and undoubtedly be considered to have low dividend payout ratios.

Pros and Cons of High Dividend Payout Ratios

Pros

👍 Enticing to income investors

High dividend payout ratios are enticing to potential investors. High dividend payments may be important to income investors and therefore useful as advertising techniques to win their investment. 

Two comparable companies with vastly different dividend payout ratios will be easily distinguishable to an income investor, who is very likely to purchase shares of the high dividend payment ratio option.

Cons

👎 Difficult to maintain

High DPRs can be difficult to maintain. If a large number of investors choose to purchase shares in a company because of their high dividend payout ratio, and then the company begins to lose money, they may be forced to lower their dividend payout ratios and sacrifice the income from investors. 

👎 Limiting to company expansion

If a large chunk of income is being dispersed to dividend investors, those funds can no longer be used internally to expand or improve the company. Rather than reinvest these profits into the company, they are given to shareholders, therefore limiting growth.

Pros and Cons of Low Dividend Payout Ratios

Pros

👍 Irrelevant if the company is able to accumulate investment

Companies that are able to accumulate investment with low dividend payout ratios may be enticing to investors regardless of the value of their DPRs. This means that there must be value in the premise of the company, its leadership, or some other aspect of the business.

👍 Reinvestment and expansion

Low dividend payout ratios allow businesses to reinvest income into expansionary strategies. Instead of giving away funds to investors, they can be used to spread brand awareness or aid the company wherever there may be a fault. This can be incredibly useful to companies that are relatively new and increasingly reliant upon their ability to expand effectively. 

Cons

👎 May repel income investors

Income investors will most likely steer clear of a business that offers a low dividend payment ratio. This means that potential investors may choose to invest with competitors instead. Total dividends offered and a company's share price may be manipulated to combat this, but high dividend payout ratios are often hard to overcome.

👎 Missed opportunity for a company to earn more

Companies may underestimate their potential by implementing low dividend payout ratios. It is possible that a company will boom because its brand or product is just that good, meaning it doesn’t need a low DPR to expand. That being said, profitable quarters for a company with a low DPR may have been more profitable if the company had increasingly implemented higher DPRs and earned more investment. 

In other words, if the company's earnings were strong enough, according to their income statement, then a higher percentage of the company's net income could have been allocated towards the company's dividend payout ratio. The increase in dividend income likely would have enticed more investors and increased the overall growth potential of the company.

Key Takeaways

  • Dividend payout ratios are calculated by dividing total dividend payments by total company profit (see example above). High yields are enticing to income investors who seek to earn returns through dividend payments.
  • Dividend payout ratios are a strong metric of comparison between companies. Other strong metrics of comparison for competitors include price-earnings ratios.
  • High dividend payout ratios are typically above 23%, while anything below 14% is often considered low. These values are not concrete by any means, as investors have varying ideas in terms of what thresholds should be established for low/high dividend payout ratios. However, it is quite commonly accepted that these values are a reliable benchmark for distinguishing between the two.
  • Higher dividend payout ratios often encompass a certain maturity in a company. This is why blue-chip companies offer such high DPRs. Companies with high payout ratios can either be uninterested in expanding further, or able to do so without reinvesting substantial amounts of their income.
  • Low dividend payout ratios are mostly associated with expansionary companies that haven’t necessarily obtained the same maturity. Companies with low payout ratios are most likely interested in reinvesting funds, at least more so than they are interested in increasing dividend payout ratios. Oftentimes, younger companies with publicly traded outstanding shares will fall into this category.
  • EPS, or earnings per share, reflects the amount an investor makes per share they own. This is reflective of company profitability, but it is not exactly the same as dividend payout ratios. Earnings per share measures how profitable a company is per each share of its stock. DPS, or dividends per share, however, measures the percentage of a company's earnings that is paid out to shareholders.
  • Several reliable DPR calculators exist and will automatically calculate the payout ratio for you.

The information provided herein is for general informational purposes only and is not intended to provide tax, legal, or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security by Candor, its employees and affiliates, or any third-party. Any expressions of opinion or assumptions are for illustrative purposes only and are subject to change without notice. Past performance is not a guarantee of future results and the opinions presented herein should not be viewed as an indicator of future performance. Investing in securities involves risk. Loss of principal is possible.

Third-party data has been obtained from sources we believe to be reliable; however, its accuracy, completeness, or reliability cannot be guaranteed. Candor does not receive compensation to promote or discuss any particular Company; however, Candor, its employees and affiliates, and/or its clients may hold positions in securities of the Companies discussed.