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Recommended Payout Ratio for Dividend Stocks

Original post by Alexander Newman of Demand Media

Dividend payout ratios (DPR) describe what percentage of company profits a business pays out to shareholders in the form of quarterly dividends. Dividends offer investors a cash return for holding onto a stock every quarter. Investors usually consider any ratio between 25 and 50 percent a good DPR based upon current market conditions and the sector of a publicly listed company, according to Passive Family Income.

Considerations

Investors combine DPR with other metrics in order to determine what companies have the potential to pay out higher dividends in the future and whether companies can continue to pay out dividends at current rates. They can calculate the dividend payout ratio (DPR) by dividing the annual dividend per share by the earnings per share (EPS). For example, a company that features a $1 dividend and $4 in EPS has a dividend payout ratio of 25 percent.

Time Frame

Whether the economy currently suffers from a recession or economic growth will influence an investor's perception of a good payout ratio. When businesses have difficulty obtaining credit during a recession, they may offer a higher DPR in order to attract investors, according to Dividend Money. In good times, companies will usually expand their operations, resulting in more profits reserved for expenditures and a DPR ratio of 25 percent or less.

Size

Established companies in the retail and energy sectors typically have less room for growth. As a result, they usually pay higher DPRs of up to 50 percent in order to prevent investors from selling their stock and investing in a growth company. Small companies undergoing rapid expansion will not usually offer a dividend and therefore have a DPR of 0 percent. Energy trusts, regardless of size, typically have a DPR of 75 percent or higher to attract investors. Companies with high expenditures due to fierce competition, such as those businesses in the technology sector, will usually have a DPR under 25 percent.

Warning

Investors should perform due diligence when considering an investment in a company with a dividend payout ratio in excess of 50 percent. A company that distributes most of its profits to shareholders can have difficulty with cash flow if economic conditions change, leaving the business insolvent or bankrupt. In addition, companies with high DPRs will not have the cash flow to expand their operations, an especially important consideration for young or expanding companies. Alternatively, a failing company in desperate financial straits may increase its dividend payout ratio to try to retain investors.

                   

References

About the Author

Alexander Newman has been a freelance writer since 2005, specializing in mental health issues, technical writing and literary journalism. He contributes to various websites and holds a Bachelor of Arts in biology from Virginia Tech.

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