Level 6 · Financial Ratios
Dividend Ratios
How much profit is handed back, and whether the company can keep doing it.
In this lesson
What you'll be able to do
- Calculate dividend yield and payout ratio
- Judge dividend sustainability
- Understand the growth-versus-payout trade-off
- Spot unsustainable payouts
Think about it
A stock shows a 12% dividend yield. Why might that be a warning rather than an opportunity?
Story
Let's picture it
A mango orchard owner can either give the entire year's earnings to his family, or spend part of it planting new trees. Give everything away and the family eats well this year but the orchard never grows. Plant too much and there is nothing to enjoy. Dividend policy is exactly this choice, at corporate scale.
Visual
Profit's two destinations
Net profit earned
The year's profit after tax
Dividend paid out
Cash returned to shareholders
Retained earnings
Profit kept for reinvestment in the business
The trade-off
High payout suits mature firms; retention suits growing ones
Plain English
The simple explanation
Dividend yield is dividend per share divided by share price. Payout ratio is total dividend divided by net profit, the share of earnings distributed.
A very high yield often results from a falling share price rather than a generous dividend. Always check why the yield is high before treating it as attractive.
Sustainability is the real question. Compare dividends against free cash flow, not just profit. A dividend paid out of borrowings or asset sales cannot last.
Real world
Indian PSUs
Several public-sector companies in India have paid high dividends supported by strong cash generation. Studying whether the dividend is comfortably covered by free cash flow, rather than simply looking at the yield, is what separates analysis from assumption.
Watch out
Common mistakes
- Treating high yield as automatically attractive.
- Ignoring whether free cash flow covers the dividend.
- Expecting high growth and high payout simultaneously.
Did you know?
Retained earnings, profit not paid out, are the largest source of funding for growth for most established companies, ahead of both debt and new equity.
Your turn
Mini challenge
Find one company's dividend yield and payout ratio. Is the dividend covered by free cash flow?
Quick quiz
1 / 5
Wrap up
Summary
Dividend yield and payout ratio show how much profit is returned to shareholders. Sustainability depends on free cash flow coverage, not on the headline yield.
- Yield = DPS ÷ price
- Payout = dividend ÷ net profit
- High yield can mean a falling price
- Check dividends against free cash flow
Revise