BAJAJ BROKING
March 01, 2025
7 mins read
The Dividend Payout Ratio (DPR) is one of the simplest and most effective financial indicators. It is calculated by dividing a company’s dividend payout by its net profit. Read more..Investors can draw interesting insights about a company’s financial health by analysing its DPR over a period of time. However, DPR tends to vary from industry to industry, which must be kept in mind when comparing the performance of two companies on this parameter. If a company’s DPR increases over a period, it could mean that it is entering a mature phase, which does not require it to reinvest a large portion of its earnings into business. Hence, it can pay a high DPR. Conversely, if a firm’s DPR decreases consistently, it could mean that it has to considerably invest in its business or has to pay certain financial obligations, which makes it difficult to increase its dividend payouts. Read less
The Dividend Payout Ratio is a popular financial indicator in the stock market, which is based on only two numbers: a company's net profit for a financial period & its dividend payout in the same duration. It simply means how much of a company's net profit is paid as dividends to its shareholders. While it may appear too simple as an indicator, it can help you develop a deep understanding of a company's financials and strategy.
DPR is a ratio of the amount of dividends paid by a company to its shareholders to its net profit. If a company’s dividend payout ratio is 20%, it means that it has paid 20% of its net profits as dividends to its shareholders.
In most cases, companies do not pay their entire net profit to shareholders as dividends. Companies usually retain a portion of their earnings to either reinvest in the business or pay certain obligations.
Those investors that prefer to receive a considerable income through dividends usually prefer companies with a high dividend payout ratio. However, there are investors that prefer companies that reinvest most of their earnings back into the business. Hence, they invest in companies with a low dividend payout ratio. Having learnt what the dividend payout ratio is, let us delve deeper into this topic.
Let us explain the concept of the dividend payout ratio with an example. Suppose a company called ABC Ltd. has reached a stage, wherein it does not need to reinvest a considerable portion of its net earnings back into its business.
ABC Ltd. has become a mature company, which does not grow at a very high rate. Hence, it does not have to reinvest a lot into its business. Therefore, it decides to pay a considerable portion of its net profit to its shareholders as dividends.
Let us say that it earned a net profit of ₹ 100 crore and it decides to pay ₹ 70 crore as dividends. In this case, its dividend payout ratio is 70% (₹ 70 crore / ₹ 100 crore).
You can calculate the dividend payout ratio of a company by using the formula given below:
Dividend Payout Ratio (DPR) = Dividends paid by a company in a period / Net profit earned by the company in the same period.
There is another formula for the dividend payout ratio, which is as follows:
Dividend Payout Ratio (DPR) = Dividends Per Share / Earnings Per Share
How to Calculate the Dividend Payout Ratio?
Let us say that a company called XYZ Ltd. paid ₹ 20 crore as dividends to its shareholders, while it earned ₹ 200 crore as net profit. In this case, its dividend payout ratio is 10% (₹ 20 crore / ₹ 200 crore). Now that you know how to calculate the dividend payout ratio, let us discuss other aspects related to it.
Developing a profound understanding of the dividend payout ratio (DPR) can help you analyse in which direction a business is going. For example, if a firm is not able to grow its business at a very high rate, it can choose to increase its DPR because it does not have to invest a lot into the business. However, if a company wants to grow significantly, it may have to retain a large portion of its net profit, thereby reducing its DPR.
Sustainability of Dividends
When assessing a company’s financials, you should analyse whether its dividend payouts are sustainable or not. In simple words, dividend sustainability means whether a company can sustain a certain level of dividend payout for a long time.
If a firm is unable to pay a specific level of dividends to its shareholders, you should analyse the reasons behind it. However, before carrying out this analysis, you should not consider the DPR of a particular year in isolation.
Often, the DPR of companies varies from one year to another due to a variety of reasons. Hence, it is better to consider the average DPR over the last few years.
Suppose you find that a company is sustainably paying dividends over the years. Moreover, its DPR is marginally increasing, too. This means that the company is willing to pay a higher portion of its net profit to its shareholders as dividends.
You should ask why the company is doing so. It could be that it is becoming a mature business, which means its revenue is not likely to grow at a high rate. Hence, it is not expected to invest a lot of its earnings into business.
Let us take another example. Suppose a company is not able to sustainably pay dividends. It could be that it has to invest in research and development (R&D). It could also be that it has to pay certain financial obligations. As an investor, you need to analyse the underlying reason behind this trend.
Analysing dividend sustainability can not only tell you whether a company can regularly pay dividends or not, but it can also tell you about its overall business and financial strategy.
Dividends Vary by Industry
The dividend payout ratio tends to vary from industry to industry. For example, those industries that need to invest a significant portion of their earnings into their business tend to have a low DPR. This is because they need to retain a large part of their earnings for reinvestment in order to grow.
Similarly, companies that need to invest a lot in R&D also have to plough a high portion of their earnings back into their business. Consequently, if at all they pay dividends, they have a low DPR.
But, companies that do not need to invest a lot into their operations and do not have other financial obligations tend to have a high DPR. Such companies can pay high dividends to their shareholders because they do not have other financial commitments.
Dividend Payout Ratio and Dividend Yield are related but different concepts. As already explained, DPR means what percentage of a company’s net profit is distributed as dividends to its shareholders.
However, dividend yield means how much return an investor will get in the form of dividends by buying a company’s stock. Let us say that a firm’s stock is trading at ₹ 100 a share and it announces a dividend of ₹ 5 per share. In this case, the dividend yield is 5% (₹ 5 divided by ₹ 100).
If you want to understand a firm’s business and financial strategy, then DPR is the right metric for you because it shows a firm’s capacity to pay dividends. However, if you are keen to know how much a stock can pay in the form of dividends relative to its price, then you should consider dividend yield as an indicator.
Dividend sustainability means whether a company can sustainably pay dividends or not. Dividends are one of the ways for a firm to reward its shareholders. If not for dividends, the only other way to generate a return on your investment in a company is by selling its stock.
Therefore, investors should be concerned when a company is unable to pay dividends sustainably. However, if a company is not able to regularly pay dividends, it does not mean something is necessarily wrong with its management.
It could be that it has to invest in R&D or it wants to improve its factory’s capacity in anticipation of revenue growth. Hence, it has to invest in its business, which requires it to retain a large portion of its earnings. Therefore, context is extremely important when analysing dividend sustainability.
The dividend payout ratio is an important concept for experienced investors and also for those who are about to open a demat account and begin investing. As a concept, it is easy to understand. However, a lot depends upon the characteristics of an industry. So, before analysing DPR, you should develop a thorough understanding of an industry, which will provide you with a strong foundation for interpreting a company’s dividend-related strategy. Lastly, the decision to invest in a company or not should not be a function of its DPR alone because one indicator may provide false signals. Hence, you should make such decisions after considering a number of indicators.
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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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A high dividend payout ratio shows that a firm is paying a significant part of its net profit as dividends to its shareholders. Typically, such firms tend to be mature businesses, which do not grow at a high rate. Hence, they do not have to invest much of their earnings into their business.
The dividend payout ratio indicates how much percentage of a firm’s earnings is paid out to its shareholders as dividends. However, dividend yield shows how much dividends you will earn by investing in a company at its current market price.
Yes, a company can have a dividend payout ratio of more than 100%. In that case, it will pay more dividends than its net profit. However, it is often not sustainable.
Dividends are one of the ways to generate a return by investing in a company. Besides, DPR can help you analyse a company’s financial position. Hence, it is important.
Changes in the dividend payout ratio can help investors analyse the direction in which a company is heading. Hence, it can impact a company’s stock price.
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