Advertiser Disclosure

advertising disclaimer
Skip to main content
payout ratio sign on money

What is a Payout Ratio?


Nov 12, 2019 by Matt Frankel, CFP
FREE - Guide To Real Estate Investing

Take the first step towards building real wealth by signing up for our comprehensive guide to real estate investing.

*By submitting your email you are agreeing to our Terms & Conditions.

In investing terms, a payout ratio is the percentage of a company's income that's paid out to shareholders as dividends. If a company earned $10 million in a quarter and paid out $4 million, it would have a 40% payout ratio.

Payout ratios are based on the dividends paid out to common stockholders. Any dividends paid to preferred stockholders aren't included in the payout ratio calculation. They're accounted for differently on a company's income statement.

Specifically, preferred stock dividends are already subtracted from the company's net income before per-share earnings are calculated.

How to Calculate the dividend payout ratio

The general formula for payout ratio is quite simple. Take the company's dividends per share, divide them by earnings per share, and multiply the result by 100 to convert it to a percentage.

You can use any time period to calculate a payout ratio. You could calculate a company's payout ratio for a particular quarter, for example.

However, most payout ratio calculations use annual numbers. Using the last four quarters of dividends and earnings is a common calculation method.

Alternatively, if a company recently raised its dividend or if future earnings are expected to be significantly different, using the projected current-year numbers or the next four quarters of expected dividends and earnings could be the best choice.

Here's a real-world example. Take a look at Apple's (NASDAQ: AAPL) earnings and dividends for the past four quarters:

Quarter Earnings Dividends
Q1 2019 $4.18 $0.73
Q2 2019 $2.46 $0.77
Q3 2019 $2.18 $0.77
Q4 2019 $3.03 $0.77
Total $11.85 $3.04

In this case, you'd divide the $3.04 in dividends by the $11.85 in earnings and multiply by 100. This shows that Apple's payout ratio over the past four quarters has been approximately 26%.

REITs are a special case

There's a special consideration when it comes to computing payout ratios for real estate investment trusts, or REITs.

In a nutshell, the traditional methods of calculating earnings don't translate well to companies with lots of real estate assets. Without getting too deep into the details, real estate earnings contain an accounting item known as depreciation. This shows up as a huge "expense" on a REIT's earnings report, although it doesn't actually cost anything.

For this reason, REIT earnings are best expressed by a metric known as funds from operations, or FFO. This adds depreciation back in and makes a few other adjustments to better reflect how profitable these businesses actually are. Many REITs also report company-specific versions of FFO, such as core FFO or adjusted FFO.

Here's the point: When calculating the payout ratio for a REIT, use per-share FFO, not per-share earnings, in the calculation.

How to use the payout ratio in your analysis

The payout ratio is most useful for evaluating the sustainability of a stock's dividend. A payout ratio above 100% means a company is paying out more than it's earning. That could indicate an imminent dividend reduction.

There's no specific cutoff when it comes to what payout ratio is too high. For most stocks, I like to see payout ratios of 50% or lower, but this can be flexible, depending on the situation. In the case of REITs, which are required to pay out most of their income, an FFO payout ratio in the 70% to 90% range is quite common, but any closer to 100% could be a cause for concern.

Finally, remember that payout ratio is just one piece of stock analysis. Just because a company has an acceptable payout ratio doesn't mean it's in good financial shape. Look at the entire picture of a company's financial condition and valuation before making an investment decision.

Unfair Advantages: How Real Estate Became a Billionaire Factory

You probably know that real estate has long been the playground for the rich and well connected, and that according to recently published data it’s also been the best performing investment in modern history. And with a set of unfair advantages that are completely unheard of with other investments, it’s no surprise why.

But in 2020 the barriers have come crashing down - and now it’s possible to build REAL wealth through real estate at a fraction of what it used to cost, meaning the unfair advantages are now available to individuals like you.

To get started, we’ve assembled a comprehensive guide that outlines everything you need to know about investing in real estate - and have made it available for FREE today. Simply click here to learn more and access your complimentary copy.

Matthew Frankel, CFP owns shares of Apple and has the following options: short October 2020 $140 calls on Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has a disclosure policy.