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A company’s dividend payout policy is the decision about the distribution of the company’s profits to its shareholders. A dividend payout policy of a firm is a financial decision that involves decisions on dividend payout ratio, and the frequency of dividends.

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The dividend decision of a firm depends on the profits, investment opportunities in hand, availability of funds, industry trends in dividend payment, and company’s dividend payment history.

  • Profits: Dividend distribution happens from the profits of the company. If the company has no profits for that financial year, then the company will not be able to pay dividends.
  • Investment opportunities: If the firm has expansion plans that would lead to the growth of the company. Then the firm would retain back the profits to reduce the cost of funding the new projects.
  • Availability of funds: The availability of funds will affect firm dividend policy. If the firm has retained earnings that would fund the new project, then the firm will be able to distribute dividends despite having new projects in hand.
  • Industry trends in dividend payment: A company has to keep up with the industry’s dividend payment standards to survive. Else the shareholders might liquidate their shares in the company to invest in competitors companies.
  • Company’s dividend payment history: A company that is paying regular dividends tends to keep the dividends stable over the years. They either keep the dividend payout ratio stable or the dividend amount stable.

Explore: Dividend Reinvestment Plans

What is a Dividend Payout Ratio?

The dividend payout ratio is the ratio of the total amount of dividend in proportion to the net income of the company. A dividend payout ratio is the percentage of total earnings paid to the shareholders in the form of dividends. The company retains the amount of earnings not distributed to shareholders. Such a retained income is used by the company for the purpose of paying its debts, loans and liabilities, reserve for contingencies, support its operations and expanding its business.

The proportion of payout of earnings depends on the company’s level of maturity, growth, debts, existing reserves, expansion plans, and so on. Historically, a large cap company has a higher dividend payout ratio than a small cap company. In a way, a dividend payout ratio is also an indication of how much earning a company is paying out to its shareholders and how much the company is retaining to support its functions, operations, increase its reserves, debts and liabilities.

Dividend Payout Ratio Formula

The Formula for the Dividend Payout Ratio is –

Dividend Payout Ratio = Dividend per Share / Earnings per Share (EPS)

Where,

Dividend per share = Total Dividend Paid/ Number of Shares,

Earning per Share = Net Income or Total Earnings / Number of Shares

How to Calculate Dividend Payout Ratio?

A dividend payout ratio can be calculated using 2 formulas. To begin with you can calculate payout ratio as yearly dividend per share divided by the earnings per share. Furthermore, it can also be calculated by dividing the total dividend paid with the net income for the year.

Alternatively, you can also calculate the dividend payout ratio as 1 – Retention Ratio.

Retention Ratio = (Earning per share – dividend per share)/ earning per share.

For Example

XYZ Limited announced a dividend payout of Rs 20 lakhs to its 2 lakh shareholders. For the financial year 2020-21 the company has earned a net profit of Rs 4 crores.

Dividend payout ratio = Total dividend paid/ Net Income or Profit

= Rs 20 lakhs/ Rs 4 crores

= 5%

Dividend payout Ratio = Dividend per share/ earnings per share (EPS)

Dividend per share

= Total Dividend Paid/ Number of Shares

 = Rs 20 lakhs/ 2 lakh Shares

= Rs 10 per share

Earning Per Share = Net Income or Total Earnings/ Number of Shares

= Rs 4 crores / 2 lakh Shares

= Rs 200 per share

Dividend payout ratio = Dividend per share/ earnings per share (EPS)

= Rs 10 per share/ Rs 200 per share

= 5%

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How Often Do Companies Payout Dividends?

Most companies pay dividends every quarter (four times a year). They often pay upon declaring their quarterly account. However, dividend payout frequency may vary from company to company. Some companies may pay every six months (semi-annually) or annually or no set schedule (irregular dividends).

Company’s earnings are paid as dividends to the stockholders. In simple terms, investors earn for owning the stock. For dividend payouts, the following are the four important dates to remember:

  • Declaration date: It is the date when the Board of Directors of a company declare their intention to pay a dividend. For accounting purposes, the company on this day creates a liability in its books. It now owes the money to its shareholders. On this day, they also announce the date of record and payment date.
  • Date of record: The date of record is the date on which the company reviews and determines who the shareholders are. An investor has to be the ‘holder of record’ to be eligible to receive a dividend payout. The shareholder on or before the ex-dividend date will receive the dividend.
  • Ex-dividend date: Ex dividend date is an important date for dividend investors. To be eligible for dividend payouts, an investor must purchase the shares of the company prior to the ex-dividend date.
  • Payment date: It is the date on which the dividend is given to the shareholders of the company.

What is a Dividend Yield?

A dividend yield is a financial ratio that expresses the company’s dividend payout relative to its share price every year. Many companies pay a periodic dividend, say monthly, quarterly, half yearly, or yearly. Hence, to calculate the dividend yield you must take the sum of dividends paid during the year. You can refer to the cash flow statement of the company for the respective financial year to know the actual dividend paid. This approach is fruitful if you want to calculate the dividend yield just for the last financial year at a particular date. 

If you want to calculate the yield applicable over a period of time then the above approach might give you an inflated dividend yield.

However, if you want to ensure you have accounted for uncertainties then you must consider a history of dividend payments made by the company to understand the trend of payments. After knowing the historical dividend payouts you can calculate the dividend yield.

What is the Difference between Dividend Yield and Dividend Payout?

A dividend yield is a ratio that indicates a rate of return in the form of dividends while a dividend payout is an indication of how a company pays its dividend as a part of its net earnings.

A dividend yield is a commonly used financial ratio used by investors to evaluate the rate of return in the form of dividends. A dividend yield is also used to understand the company’s abilities to deliver such a rate of return in the future. On the other hand, the dividend payout ratio is connected with the cash flow of any company. 

What is a Good Dividend Yield?

A good dividend yield is anywhere between 4% to 6%. It depends on market conditions and interest rates. However, the yield alone cannot be a good indicator to buy a company’s share.

For example, an investor holds shares of company XYZ Ltd. XYZ Ltd., share price falls by 20% in a year, and the company announces a 5% dividend. The fall in the price of the share is much higher in comparison to the dividend announced. Therefore, it doesn’t matter how much the dividend is or whether it is good.

Also, a high dividend yield may indicate that it is not safe and that the rate might be cut in the future. Hence, it is always advisable to proceed with cautions when investing for dividend income.

Learn Dividend Distribution Tax (DDT)

Frequently Asked Questions

How often do dividends payout?

Most companies pay dividends every quarter (four times a year). They often pay upon declaring their quarterly account. However, dividend payout frequency may vary from company to company. Some companies may pay every six months (semi-annually) or annually or no set schedule (irregular dividends).

What is a dividend payout policy?

A company’s dividend payout policy is the decision about the distribution of the company’s profits to its shareholders. A dividend payout policy of a firm is a financial decision that involves decisions on dividend payout ratio, and the frequency of dividends.

What are the four types of dividends?

Following are the four types of dividends: Cash Dividend: which is the most popular and common form of dividend payout, Stock Dividend: It payout when the company issues additional shares to its common shareholders without any consideration. Property Dividend: company can always issue a non-monetary dividend to its shareholders. and Scrip Dividend: In a scenario where the company does not have enough dividend, it may pay dividends by issuing the promissory note.

What is an annual dividend?

The total value of dividends paid by a company to investors in a year is the annual dividend. In other words, the annual dividend is an indicator of per share or aggregate of dividends paid to the shareholders during a year. The annual dividend per share, divided by the share price determines the dividend yield.

What is the difference between the interim and final dividend?

Difference between the interim and final dividend: The interim dividend is the dividend that a company pays during the financial year before the company’s Annual General Meeting (AGM) and releasing the financial statements. The final dividend is paid after the financial results are declared. The shareholders declare the final dividend in the AGM, and the company pays it from current earnings. 

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