The Payout Ratio is simply the percentage of earnings that is paid out in the form of dividends. I like to keep an eye on the payout ratio of companies I invest in because if they are paying out more in dividends that they are earning then the dividend isn't sustainable for long. Sooner or later the dividend will have to be cut because the company cannot payout money it doesn't have for long. The only way a company can pay a larger dividend than it's earnings is by either borrowing money or selling off part of the company. Neither of these strategies is good for the financial health of the company and therefore it's not good for my financial health either.
Most smaller companies that are in there growth phase will payout little or nothing in the form of dividends so their payout ratios are usually near zero. Older larger companies tend to have less internal growth potential and tend to pay out a larger portion of their earnings in the form of dividends.
One unique situation are the REITs and BDCs which by law payout 90% or more of their earnings. These companies generally have little or no internal growth potential and are generally just finance companies. They borrow money at low interests rates and then loan it out at a higher interest rate. The spread between the two rates is their profit margin and as long as they payout 90% or more of their earnings they don't have to pay any taxes.
For a better explanation of the Payout Ratio please see the video below presented by Perfect Stock Alert. They consistently do an excellent job of explaining these difficult concepts.
Most smaller companies that are in there growth phase will payout little or nothing in the form of dividends so their payout ratios are usually near zero. Older larger companies tend to have less internal growth potential and tend to pay out a larger portion of their earnings in the form of dividends.
One unique situation are the REITs and BDCs which by law payout 90% or more of their earnings. These companies generally have little or no internal growth potential and are generally just finance companies. They borrow money at low interests rates and then loan it out at a higher interest rate. The spread between the two rates is their profit margin and as long as they payout 90% or more of their earnings they don't have to pay any taxes.
For a better explanation of the Payout Ratio please see the video below presented by Perfect Stock Alert. They consistently do an excellent job of explaining these difficult concepts.
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