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The dividend payout ratio is one tool that successful income investors rely on to help evaluate companies to invest in.
One technique often used is to look for companies on a published list, such as the Dividend Aristocrats Index. This index includes stable companies that are well managed and have a strong history of increasing their dividends each year.
Well known dividend payers like McDonald’s (MCD) and Coca-Cola (KO) are found on the index.
The Dividend Aristocrat Index has already done a lot of the heavy lifting when searching for quality income stocks. That is why I have personally used this list for many years when looking for dividend stocks to add to my portfolio.
Another set of tools that dividend investors use to screen for stocks are a collection of financial ratios. These calculations typically detail a company’s dividend performance – both past and present, along with other important metrics.
A few of the more common ratios that I use include –
- dividend yield – measures the cash flow an investor will receive for each dollar they invest in a given stock at the current share price
- price to earnings (PE) – helps tell an investor if a stock is overpriced in the current market
- dividend growth rate – annual percentage dividend increase during a period of time
The dividend payout ratio is another important metric that successful investors use to look for quality companies. This calculation can help investors find companies that offer sustainable dividends that have the potential to grow each year.
I personally rely on the dividend payout ratio more heavily in my stock screening, compared to more common calculations. That is because I prefer to invest in boring, but stable companies that grow their dividend each year at a healthy rate.
Let’s dive into more about this useful calculation and how it can help you build and grow your dividend income stream.
How to Calculate the Dividend Payout Ratio
The Dividend Payout Ratio (DPR) is actually very simple to calculate.
The ratio is calculated by dividing a company’s annual dividends per share by the earnings per share (EPS) for the same period of time.
This calculation can be done by the investor. Or to save time, this information can usually be found on your online brokerage account or from well known financial web sites like Yahoo Finance.
The dividend payout ratio formula looks something like this –
Dividend Payout Ratio = (Annual Dividend per Share / Earnings per Share) * 100
So a simple example (from a made up company) may look something like this –
- annual dividend per share (from previous year) = $2.00
- earnings per share (from previous year) = $4.00
Plugging those values into our calculation, we’d get the following results –
DPR = ($2.00 / $4.00) * 100 = 50.0%
We can get into the details of what these results mean later.
However, for now just know that our fictitious company paid out half of their earnings (or 50%) the previous year in dividends to it’s shareholders.
Now let’s look at a real life example from one of my favorite dividend paying stocks – Johnson & Johnson (JNJ).
Dividend Payout Ratio Real Life Example
Let’s take a look at a real example of how to calculate a company’s DPR from one of my current holdings – JNJ.
To see all of our current holdings, please refer to the dividend stock portfolio page.
Johnson & Johnson is a member of the Dividend Aristocrat index and has been consistently raising dividends for over the past 50+ years.
At the time of this original writing (way back in 2014), the company paid an annual dividend of $2.64 per share.
In addition, for the trailing 12 months at that time, the company reported earnings per share of $4.81
So just like in our example previously, we can simply plug these numbers into the formula to calculate the dividend payout ratio for JNJ.
DPR for JNJ (2014) = ($2.64 / $4.81) * 100 = 54.89%
So back in 2014, Johnson & Johnson had a dividend payout ratio = 54.89%.
What does this mean? The company at the time was using almost 55% of its earnings to payout dividends to shareholders.
It is also important to point out that over time, the dividend payout ratio for a company will likely fluctuate.
For example, if we look at our formula in 2020 for Johnson & Johnson, we will see the following –
- annual dividend per share = $4.04
- earnings per share (from previous year) = $6.36
DPR for JNJ (2020) = ($4.04 / $6.36) * 100 = 63.52%
So as you can see, the company is now paying out almost 64% of their earnings back to shareholders in dividends.
In my opinion, this is still an acceptable payout (not too high). However, you can clearly see the company is now paying out more of it’s earnings in the form of dividends.
Note – The Dividend Payout Ratio can often be found right along with other important metrics of a company on financial websites. However, it can be helpful to calculate it on your own to understand where the numbers are coming from.
Next, let’s take a look at how to interrupt what these numbers actually mean.
What is a Good Payout Ratio
Calculating the dividend payout ratio of a stock is useless if you don’t know how to use that information.
Should I invest in Johnson & Johnson stock since they currently have a payout ratio around 64%? Well that depends on several factors actually … not just payout ratio.
Remember those other calculations like dividend yield and PE ratio I mentioned at the start? A smart dividend investor would likely factor in some of those metrics too when analyzing a stock.
And a good investor wouldn’t just use the most recent dividend payout ratio either. They’d likely look at how that percentage of dividends being paid out from earnings has been trending over the years.
If the percentage keeps going up year after year (especially as it passes 60%), there could be trouble on the horizon for the company’s dividend.
As a general rule of thumb, most dividend investors (including myself) look for companies with a payout ratio that is less than 60%. This number varies a lot and I have even seen some investors use a 70% or less ratio for their screening.
It’s really up to you on what your comfort level is when screening dividend stocks. If you are interested, you can check out my stock screen steps that I use to pick companies for my portfolio.
One last thing to point out before we wrap things up – dividend payout ratios are not always useful for every type of company. REIT’s (or Real Estate Investment Trust) come to mind here as a type of dividend stock where the payout ratio isn’t very helpful.
Just remember to do your own research and put together stock screening criteria that fits your comfort level.
Percentage of Earnings Paid to Shareholders
The Dividend Payout Ratio is the percentage of reported earnings that are paid by a company to shareholders in the form of annual dividends.
The DPR can be calculated by investors or can normally be found on most financial websites or online brokers.
Many successful investors use the DPR to help them filter out stocks that may not offer a sustainable dividend. While an important metric, this ratio should be used in combination with other criteria when screening stocks.
Finally, the dividend payout ratio is best leveraged by comparing how it is trending for a company year after year. A company that continues to increase their payout ratio every year may be a signal of a future dividend cut. Whereas a company who has a stable payout ratio year over year is less likely to cut their dividend in the future.
Full Disclosure – At the time of this writing, I owned shares in the following stocks mentioned in this article – MCD, JNJ, and KO. This is not a recommendation to buy these companies. Investors should do their own due diligence before deciding to buy or sell a stock.
