Formula
Payout Ratio = Dividends Paid ÷ Net Income
The Short Version
This ratio shows what percentage of a company's earnings are being paid out to shareholders as dividends, versus retained and reinvested in the business. It helps you judge whether a dividend is sustainable.
Explain It Like I'm 10
Say you earn $10 from doing chores this week. You decide to give $4 to your little brother and keep $6 for yourself to save up for a toy. You just 'paid out' 40% of your earnings ($4 ÷ $10). Companies do the same thing with profit: some goes out the door as dividends to shareholders, and the rest stays in the business to grow it. The payout ratio just tells you what percentage went out the door.
Step-by-Step Example
- 1 Company's net income (profit) per share: $10.
- 2 Dividends paid per share: $4.
- 3 Divide: $4 ÷ $10 = 40% payout ratio.
- 4 That leaves 60% of profit kept inside the company to reinvest, pay down debt, or save for a rainy day.
- 5 If the payout ratio were 110% (paying out more than it earns), that's a red flag — it means the company is handing out more cash than it's actually making, which usually can't continue forever.
Textbook Example
A company earning $10 per share and paying $4 per share in dividends has a payout ratio of 40%.
Quick Recap
- ✓ A very high payout ratio (near or above 100%) can be a red flag — the company may be paying out more than it earns.
- ✓ Mature, stable industries (utilities, consumer staples) tend to support higher payout ratios than fast-growing companies.