A stock's dividend payout ratio refers to the percent of earnings being paid out in the form of dividends.
Like...if whatever.com is paying a 40-cent-a-share dividend, and it earned $1.00 a share, then it's payout ratio is 40%.
WDTM? Well, boards don't control stock prices. They do control a flat dollar amount allocated to be paid out in dividends, usually based on deep and solid projections of earnings the next 2-5 years. So a given company might have had earnings of $70 million, then $80 million, then $90 million, and project 10-ish percent increases the next 3-5 years. It sells baseball stuff, and while baseball is dying in America, it's getting popular in China, and Chinese players want American brands. So there's a wide moat around this baseball equipment maker, but it's in a slow, steady, pretty predictable market.
Now it's dividend time, and the board allocates $40 million for dividend payout. If earnings go to $2 a share and $200 million next year on huge Chinese demand, then the Board may have to revisit its target payout ratio of 40%, because now they're only at 20% of earnings being paid out in the form of dividends, and they'll likely get grief from shareholders, i.e. institutional investors who likely own this stock in their balanced growth-and-income portfolios, where they're crying for yield.
So it's a moving target at best, and boards have to be careful. It's always great to increase the dividend, but if they ever have to cut it or get rid of the dividend because earnings are getting hit hard by whatever force, it usually means the board is tossed out, and a new slate is elected by angry shareholders.
Not a way any board wants to strike out.
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Finance: What is Dividend Coverage/the D...7 Views
finance a la shmoop what is dividend coverage and what is the dividend payout
ratio? whatever.com has earnings big earnings a hundred million dollars worth
of earnings this year from sales of a whole lot of whatever's the board green [People working in a factory]
lights a dividend payment of 40 million bucks that is the company will pay 10
million dollars to its common shareholders of record four times in
this next year the payout is 40 million because well
you know it's paid out and yeah clever titling know is never a thing on Wall
Street and the payout ratio is 40 over a hundred that hundred million of earnings [Payout ratio calculation appears]
or forty percent well why does the payout ratio even matter?
well companies hate having to cut their dividends and they love raising them if
the former well stock prices usually crash if the latter well they usually go
up and companies love it when their stock prices go up duh so what would [Whatever.com share price rises]
happen if whatever dot-com stumbled in its earnings tumbled and then
shareholders mumbled that the earnings payout ratio had crumbled that is... okay
stop with the rhyming bad timing okay now we're stopping and yeah that is what
if the earnings of whatever.com went down next year to only 50 million
remember they were a hundred million now they're only 50....hmm
problem because now the payout ratio is 80 percent 40 over 50 yeah very
difficult situation the company thought it would have tons of earnings to cover
its dividend at the forty million dollar level more or less forever
but clearly it did not so now what well if earnings recover and go back to a [Man discussing whatever.com's earnings]
hundred million dollars on their way to the 300 million they projected well,
then life is grand no sweat no heavy decisions to be made
but what if earnings fall further to be only thirty million the following year
well then whatever dot-com has to either borrow money or deplete its cash
reserves just to cover its dividend in which case the payout ratio would then
be over a hundred percent meaning that the earnings were 30 million and the [Earnings appear]
dividend was to be forty well then the payout ratio would be 40 over 30
133% ouch can't do that for very long without going bankrupt so payout ratios [Wheel spins and lands on bankrupt]
matter because they give a sense for the safety or certainty that that dividend
will continue at its present rate if the ratio is low well odds are good the
company could certainly afford to raise the dividend over time or at least not
cut it yeah for a very long time ideally and if the ratio is high well your [Dividend cut with scissors]
bottom line may soon be bottoming out back-end load there if i ever saw it...