The dividend payout ratio is often an overlooked calculation in the investment world. The ratio represents how much companies are paying out to shareholders from their overall earnings. Most growth companies that pay dividends have a very low payout ratio, while establish companies have a higher ratio. This ratio can be an extremely important piece of data used in decision making on whether to buy or sell a dividend paying stock.

Many investors prefer to focus on the actual earnings per share instead of worrying about how much is being paid out to shareholders. Dividend growth investors, on the other hand, normally use this calculation as a future indicator. A company with a high dividend payout will tend to have a much harder time maintaining their yield. On the other hand, a company with a lower ratio will find it much easier to maintain their current yield. These simple indicators can offer a wealth of information to investors of dividend paying stocks.

Interested investors can learn more about how to calculate a dividend payout ratio below.

Dividend Payout Ratio Calculation

Stocks that pay dividends all have a dividend payout ratio that can be calculated. This ratio may be published on financial websites or available through your online discount broker. A dividend payout ratio can also be calculated by hand in just a few minutes. There are just two pieces of data required to run the calculation, both of which can be found through your online discount broker.

All that is required to calculate the ratio is the 12-month annualized dividend and the earning per share from the past year. The dividends per share can then be divided by the earnings per share to calculate the ratio. This information can be found on any financial website, online broker, or through the company's investor website. The calculated dividend payout ratio can also be found published on many financial websites which saves time from running the calculation.

Dividend Payout Ratio Example

The dividend payout ratio is calculated by dividing the dividend per share over the earnings per share of the company. For example, Wal-Mart Stores Inc. (WMT) posted yearly earnings per share = $3.70 and an annual dividend payment = $1.21. The dividend payout ratio for Wal-Mart would then be as follows -

Dividend Payout Ratio = $1.21 / $3.70 or 32.7%

In another example, Pfizer (PFE) pays a hefty annual dividend = $0.72 with an earnings per share = $1.08. The dividend payout ratio for Pfizer would be as follows -

Dividend Payout Ration = $0.72 / $1.08 or 66.7%

A stock with a payout ratio below 50% is often considered a safe bet for dividend investors. In the examples above, Wal-Mart would be considered an attractive position whereas Pfizer would be considered a risky dividend stock.

Final Thoughts

Dividend paying stocks can build a solid income stream for investors for many years. The consistent payments along with the potential for capital gains increases make them a wise investment choice. Using calculations like the dividend payout ratio can help investors make critical investment decisions that can change the rest of their lives.

Full Disclosure - I currently do not own any shares in Wal-Mart Stores Inc. (WMT) or Pfizer (PFE). The dividend payout ratio calculations were for presentation only.