What is a payout ratio?
In one line: The payout ratio is the share of a company's earnings, or of its free cash flow, that it pays out to shareholders as dividends.
The formula
Payout ratio = dividends ÷ earnings.
You can work it per share (dividend per share ÷ earnings per share) or in totals (total dividends ÷ net income). Both give the same answer.
A 50% payout ratio means the company pays out half of what it earned and keeps the other half. The kept half can pay down debt, fund growth, or cushion a bad year.
Three versions, three answers
The same company can show very different payout ratios, depending on what you divide by.
- Earnings (EPS). The classic version. Uses accounting profit, which can include non-cash items.
- Free cash flow (FCF). Cash from the business minus what it spends on equipment and buildings. Dividends are paid in cash, so many investors trust this version more.
- Funds from operations (FFO). Used for REITs. A REIT's accounting profit is cut by depreciation, a yearly paper charge for its buildings wearing out. No cash leaves for it, but it can make the normal payout ratio look far above 100%. FFO adds it back.
An example (hypothetical)
A made-up company pays a $2.00 dividend per share a year.
- It earned $4.00 a share. Earnings payout ratio: $2.00 ÷ $4.00 = 50%.
- But its free cash flow was only $1.60 a share. Cash payout ratio: $2.00 ÷ $1.60 = 125%.
On earnings, the dividend looks well covered. On cash, the company paid out more than it brought in. The gap has to come from somewhere: savings, borrowing, or selling assets. That can't go on for long, and it's one of the dividend trap warning signs.
A made-up REIT pays $2.40 a unit and has FFO of $3.00 a unit. Its FFO payout ratio is 80%, even if its earnings-based ratio looks scary.
How to read it
There's no one "right" number. Some rough guides:
- Lower leaves more room for a bad year, and more room to raise the dividend.
- Higher means less room. A small drop in profit can make the dividend hard to pay.
- Over 100% means the company is paying out more than it earned in that period. Fine for one bad year. A warning sign if it lasts.
- Negative earnings make the ratio meaningless. A company losing money is paying its dividend from somewhere else.
Different businesses run at different levels. Utilities and REITs usually pay out more than a fast-growing tech company. Compare a company to its own past and to its peers, not to one fixed number.
Our dividend payout ratio calculator does the EPS, FCF and FFO versions side by side.
Where it fits
The payout ratio tells you how stretched a dividend is. A high Dividend yield with a payout ratio over 100% is often a cut waiting to happen. For how it fits with the other dividend numbers, read dividend investing explained. If you sell covered calls on dividend stocks, a stretched payout is worth checking before you commit for months; the wheel strategy covers picking stocks you'd be happy to own.
Questions
What is a good payout ratio?
There's no single number. Lower leaves more room for bad years. Compare to the company's own history and to similar companies, and check the free cash flow version too.
Can a payout ratio be over 100%?
Yes. It means the company paid out more than it earned. One bad year can explain it. Several years in a row usually ends in a cut or more debt.
Why do REITs use FFO for the payout ratio?
Their accounting profit is reduced by depreciation on their buildings, which isn't a cash cost. FFO adds it back, so it shows the cash available for payouts more fairly.
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