Dividend Payout Ratio
Dividend payout ratio is the fraction of net income a company pays to its stockholders in dividends. The contribution of the earnings not paid to investors is left for investment to render for future earnings growth. Investors looking for high current income and limited capital growth do for companies with high dividend payout ratio. Even so, investors seeking capital growth may go for lower payout ratio as capital gains are taxed at a lower rate. High growth firms in early life generally have low or zero payout ratios. As they grow, they return more of the earnings back to investors. The dividend payout ratio is computed as DPS or EPS.
As per to Financial Accounting by Walter T. Harrison, the computation for the payout ratio:
Payout Ratio = (Dividends - Preferred Stock Dividends)/Net Income
The dividend yield is given by earnings yield times DPR: 
In converse manner, the P/E ratio is the Price/Dividend ratio times the DPR.
The dividend payout ratio shows how quickly the shareholders are paid. As shareholders invest in the company, they assume returns in the form of dividends and a constant dividend payout ratio is observed as an attractive characteristics to many equity investors. A company is assumed as financially healthy if it frequently pays dividends.
Dividends are declared by the board of directors of the company and this exercise triggers the recording of a financial obligations referred as dividends payable. At the end of the year, the income is credited to held back earnings and dividends are paid out from cash in hand. Therefore the financial obligations of the dividends payable gets removed.
The part of earning collected is used for investment in future growth. However investors eager for higher current income will go for high dividend payout ratio over limited capital growth. Companies in the early stages pay low or no dividend. With the passage of time, these companies enhance the return back to the investors as they are in the grow up and mature and paying out profits in the form of dividends.
In addition, if a consistent dividend paying company suddenly cuts off its payments then investors should realize that the company is facing problem and is under financial crisis. The higher dividend payout ratio mean that most of the profits are paid to the investors and less is invested back in the business to assist internal growth. If investors are ready to invest back into the business then this would lead to more growth and leads to further increase in dividends.
A dividend ratio of a single year renders an unreliable indication and thus investors should concentrate on dividends of several years in order to make comparisons. A dividend ratio can also be compared against other companies in the same sector to give a clearer picture of where the company stands.
Major drawbacks are:
Dividend payout ratio changes from company to company because big and stable companies tend to manage higher dividend payouts as compared to small growth oriented companies. Thus not every company can compare their ratios with other companies. It should also be keep in mind that dividends are paid out from cash and not from operating profit only. There is a chance that total earnings per share may include other income such as sale of properties. Investors assume from the ratio that earnings represent cash which is not the case according to accrual accounting. Thus a company cannot pay dividend in spite adequate balance in retained earnings unless it has sufficient cash.
With dividend payout ratio, one can conclude that whether companies have enough internal growth to support constant dividend increase. The major bottom line is that dividend payouts matter. Dividends are significant as they represents a company's value. Without dividend payments, investors will be unwilling to involved in investing further in the company.
Dividend Payout Ratio
Dividend payout ratio is the component of net income a business firm pays to its stockholders in dividends.
The part of the earnings not compensated to investors is left for investment to render for future earnings growth. Investors looking for high current income and limited capital growth prefer companies with high Dividend payout ratio. On the other hand investors looking for capital growth may prefer lower payout ratio due to capital gains are taxed at a lower rate. High growth business firms in early life in general have low or zero payout ratios. As they grow, they incline to return more of the earnings back to investors. Keep in mind, that dividend payout ratio is computed as Dividend Payout Ratio/Earnings Per Share.
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