Profitability and return ratios

    Dividend payout ratio

    The dividend payout ratio is the share of net profit a company distributes as dividends. What is not paid out is retained in reserves and grows the equity base.

    Formula

    Payout ratio

    Dividend Payout Ratio (%) = Total Dividends ÷ Net Profit × 100

    Retention

    Retention Ratio (%) = 100 − Payout Ratio

    Benchmark: A very high payout with a very high ROE deserves suspicion

    Reading the number

    Retained profit feeds directly into reserves, and reserves sit in the denominator of ROE. So payout policy changes ROE without changing the business at all.

    Scenario A: ₹100 of equity, ₹100 of profit, all of it paid out. Reserves stay at zero, equity stays at ₹100, and the next year's ROE looks like ₹1 earning ₹1, 100 percent. Scenario B: the same ₹100 of profit retained. Reserves become ₹100, equity becomes ₹200, and the same profit now looks like 50 percent ROE. Same business, half the ROE, purely from the payout decision.

    Some companies pay high dividends deliberately to keep the equity base small, because they know investors screen on ROE. The generous explanation is that the company genuinely has no use for the cash. The check is simple: a stock with an 8 to 10 percent dividend yield and a high payout should have its ROE read with that in mind.

    Indian example

    Related ratios

    Dividend yieldReturn on equityFree cash flow

    Glossary terms

    From the research

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