How the payout ratio works

The payout ratio asks what share of this year's profit was sent to shareholders as a dividend:

$$\text{Payout} = \frac{\text{Dividends}}{\text{Net income}}$$

On $18,000 of dividends against $45,000 of net income that is 40 percent. Retention is what was not paid: 60 percent. Return on equity on $300,000 of book equity is 15 percent.

The payout ratio calculator on this page prints payout, retention, ROE and sustainable growth from one sheet, so the rates cannot be fed inconsistent numbers. This page owns the 40 percent payout. How sustainable growth works owns $g = \text{ROE} \times b$, the 9 percent.

Payout against dividend yield is cash over profit against cash over price. How dividend yield works is the price fraction, on a different teaching sheet.

Net income $60,000, dividends $0, equity $600,000. Payout is 0 percent. Retention is 100 percent. ROE is 10 percent.

Paying nothing is a payout of zero, not a missing ratio. The whole residual stays in book equity. Sustainable growth on that sheet equals ROE, because $b = 1$. How sustainable growth works owns that reading. This page owns the 0 percent split.

The first sheet paid 40 percent of a 15 percent ROE. This sheet pays none of a 10 percent ROE. Ranking on payout and ranking on ROE are not the same order. Both rankings are the same three inputs, weighted differently.

Net income $80,000, dividends $40,000, equity $400,000. Payout is 50 percent. Retention is 50 percent. ROE is 20 percent.

The 50 percent is a different split from the first sheet's 40 percent. Ranking on payout and ranking on ROE reverse: this sheet pays more of a higher ROE. Both rankings are the same three inputs, weighted differently.

How DuPont analysis works would split that 20 percent ROE into margin, turnover and the equity multiplier. This calculator does not take sales or assets. Do not paste another sheet's sales line onto this $300,000 of equity.

It is not dividend yield. Yield is the dividend over the share price. Payout is the dividend over profit. A firm can pay 40 percent of earnings and still print a low yield if the price is high, or a high yield if the price collapsed.

It is not a cash forecast. Specials, skips and buybacks move the cash without moving this year's net income until the calendar catches up.

It is not sustainable growth. $g$ multiplies this retention by ROE. How sustainable growth works is that product.

Dividends and net income have to come from the same stretch of time. A year of profit against a special paid from last year's cash is not this year's payout. Book equity in the ROE denominator is the same period's residual claim, not market capitalisation.

A payout above 100 percent means the firm paid more cash than it earned this period. Retention then goes negative. This calculator will print that. It is a description of the year, not a perpetual policy.

It is not a yield, not a forecast, and not a target of 40 percent. The three sheets are 40 percent on $18,000 over $45,000 (retention 60 percent, ROE 15 percent on $300,000 of equity), 0 percent when dividends are $0 on $60,000 of profit, and 50 percent on $40,000 over $80,000. This is educational material, not financial advice.