Lesson 2 of 8
Reading a dividend payout ratio
The payout ratio says how much of last year's profit left as dividends. It cannot say whether the dividend is safe, and it can read above 100 percent.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- The payout ratio is dividends per share over earnings per share: how much of last year's accounting profit was paid out rather than kept.
- A ratio above 100 percent is not automatically a problem, because earnings can understate the cash a company produces.
- The retained share funds growth, so a low payout is not good in itself unless the retained profit earns a good return.
A payout ratio is a distribution statistic, not a safety test. It reports what share of last year's accounting profit was paid out as dividends rather than kept, and on its own it says nothing about whether that dividend can continue.
The same 125 percent payout, two companies
- Company E, payout on earnings125%
- Company E, payout on free cash flow · dividend covered by cash55.6%
- Company F, payout on earnings125%
- Company F, payout on free cash flow · not meaningful: free cash flow was negativen/a
Dividend equal to the year's profit: 100%
Three ratios share one name
Dividends are paid in cash, earnings are not cash, and dividends are not the only way cash leaves a company. Three different ratios all get called "the payout ratio":
| Ratio | What it asks |
|---|---|
| Dividends ÷ earnings | How much of the declared profit was paid out |
| Dividends ÷ free cash flow | Whether the cash was actually there |
| Dividends and buybacks ÷ free cash flow | What actually left the company, by any route |
The first is the one computed from two filed lines with no judgment involved, which is also why it is the one that tells you least.
Why 125 percent is not automatically a problem
The retained share is the growth rate
The profit not paid out is reinvested, and what it earns sets how fast the company can grow without borrowing or issuing shares.
Check yourself
A company pays out 125 percent of earnings, but its dividend is only 55.6 percent of free cash flow. What explains the gap?
- Depreciation exceeded capital spending, so earnings understated the cash the company produced
- The dividend was cut mid-year
- Free cash flow always exceeds accounting earnings
Show the answer
Answer: A.
When depreciation is larger than capital expenditure, reported earnings are lower than the cash actually generated, so the cash-based payout ratio can be well under 100 percent even when the earnings-based ratio is above it.Two companies both retain 60 percent of earnings. Company A earns 20 percent on equity and Company B earns 8 percent. Which grows faster without new financing?
- Company B, because it retains the same share
- Company A, because its retained capital earns a higher return
- Both grow at the same rate, since the payout ratio is identical
Show the answer
Answer: B.
The sustainable growth rate is return on equity multiplied by the retained share. The same 60 percent retained earns 12 percent growth for Company A and only 4.8 percent for Company B.Why is a real estate investment trust's high payout ratio treated differently from other companies?
- REITs are not required to file the ratio
- REIT earnings are never affected by depreciation
- REITs must distribute most taxable income to keep their tax status, so a high ratio is a structural fact rather than a warning
Show the answer
Answer: C.
A REIT's payout requirement is a rule of its tax structure, and its earnings are also depressed by property depreciation, both of which push the ratio up for reasons unrelated to financial strain.Sources
- Graham, The Intelligent Investor, revised edition 1973, chapter 12, on per-share earnings shaped by special charges and depreciation choices, including one-off distortions to net income.
- Buffett, Berkshire Hathaway shareholder letter, 1992, on growth, whose effect on value can be negative as well as positive.
What this leaves out
- The product computes this ratio from filed common dividends over filed net income, both off the same fiscal year's statements. It needs a dividend line it can read and a profit to divide by, so it is held for 1,572 of the 5,518 US listings in the pool on 2026-09-13; 242 of those read above 100 percent and are published as measured, never clamped. Where an input is missing the figure is withheld with the reason attached, never shown as zero: 3,006 listings have no dividend line on file, 269 lost money in the year, and 176 have dividends on file whose common share cannot be separated from the preferred.
- The sustainable growth arithmetic assumes new capital earns the same return as existing capital, which is rarely exactly true.
- The bar chart and the worked examples use round invented numbers so the arithmetic can be checked by hand.
- Nothing here is advice about any security.