Stock Market

Dividend Payout Ratio

The ratio between cash paid out to shareholders in the form of dividends and total earnings is known as the dividend payout ratio. A company that had net income of $10 million and paid $6 million out as cash dividends would have a payout ratio of 60 percent ($6 million dividends paid divided by $ 10 million net income).

The inverse is known as the retention ratio, and can be calculated by taking 100 percent subtracted by the dividend payout ratio. Using the same example, the retention ratio would be 40 percent (100 percent - 60 percent dividend payout ratio = 40 percent retention ratio). These concepts are extremely important because they are used to calculate a company's maximum sustainable growth rate.

Dividend Yield

Another important metric is dividend yield. It tells you how much a common stock is yielding based upon its current market price. It is calculated by dividing the annual cash dividend by the per share market value of a stock.

Take a look at U.S. Bancorp (symbol: USB). Say, the shares were trading at $29.53. The indicated annual cash dividend equaled $1.20. By dividing the dividend by the current market price, we find that the U.S. Bank's common stock is currently yielding 4.06 percent. That is, the purchaser of $10,000 worth of the stock today would expect to earn 4.06 percent, or $406, in dividend income over the next year.

TIP: Most companies pay dividends quarterly. If you open The Wall Street Journal and see that a corporation pays a $1 dividend, it is likely that you are going to receive $0.25 per share, four times a year (Jan. 1, Apr. 1, July 1, and Oct. 1, for example). Some businesses, on the other hand, pay dividends annually or semi-annually. On rare occasions, a Board of Directors may declare a special dividend. These are one-time distributions normally arising from excess funds that have accumulated or unusual, non-recurring sources, such as the sale of a business or an award from litigation.