Stockholders are entitled to a portion of a company's earnings. The company can choose to distribute a portion of its earnings as dividends to stockholders, or reinvest its earnings back into the business. The payout ratio shows the portion of a company's earnings distributed as dividends. A lower payout ratio means that a company has more earnings left over after paying its dividends, while a higher payout ratio means a company pays out most of its earnings as dividends. You can calculate a payout ratio from information on a company's financial statements.
1. Find a company's income statement and cash flow statement in its 10-K annual report. You can get a public company's 10-K annual report online from the U.S. Securities and Exchange Commission's EDGAR database.
2. Find the company's net income at the bottom of its income statement. This is the amount of earnings it generated during the year. For example, assume a company's income statement shows $1 million of net income.
3. Find the line item called "Dividends Paid on Common Stock" in the "Cash Flows from Financing Activities" section of the cash flow statement, and identify the amount listed next to the description. The cash flow statement shows the amount in parentheses to designate a cash outflow. In this example, if the company's cash flow statement shows "Dividends Paid on Common Stock ($350,000)," that means the company paid $350,000 in dividends during the year.
4. Divide the amount of dividends paid by the amount of net income to calculate the dividend payout ratio. In this example, divide $350,000 by $1 million to get 0.35, or a 35 percent dividend payout ratio. This means the company paid out 35 percent of its earnings as dividends to stockholders, which suggests the company generates sufficient earnings to afford the dividend. A higher ratio, such as 95 percent, would be cause for concern with the company distributing nearly all of its earnings.
- Compare a company's payout ratio with the industry average to assess an appropriate level of dividend distribution.
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