Payout ratio

Dividends as a share of earnings. One minus it is the retention ratio, which with ROE sets sustainable growth; a target payout is the long-run ratio a stable dividend policy moves towards.

Where you will meet it

Payout ratio appears in 9 learning outcomes on the CFA syllabus. A few of them:

• Tell apart valuation by comparables and valuation by forecasted fundamentals
  CFA Level I · Equity Investments

  “The method of forecasted fundamentals instead derives the multiple a firm should command from its own expected growth, payout and required return, for example a justified forward P/E of payout ratio / (r - g).”

• Derive justified leading and trailing P/Es from the Gordon growth model and explain what they mean
  CFA Level II · Equities

  “On forward earnings, the leading multiple is P/E = P0 ÷ E1 = (D1 ÷ E1) ÷ (r − g), the payout ratio divided by r minus g.”

• Contrast a stable dividend policy with a constant payout ratio policy and work out the dividend each would produce
  CFA Level II · Corporate Finance

  “It is often modelled with a target payout adjustment, in which the expected dividend is D1 = last dividend + (expected EPS × target payout − last dividend) × adjustment factor, where the factor is one divided by the number of years over which the gap is closed.”

• Explain the growth, transition and maturity phases a business passes through
  CFA Level II · Equities

  “In the transition phase, competition arrives, growth slows towards the economy's rate, margins narrow, investment needs ease and the payout ratio rises.”

See also

Retention ratio · Stable dividend policy

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
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All terms beginning with P · Glossary