The dividend payout ratio is a simple yet vitally important statistic for any dividend investor to be aware of. It is a calculation of how much of the profit the business is paying out as a dividend.
A high payout ratio or low payout ratio is not necessarily a bad thing. The more profit a business pays out the bigger the dividend will be for the shareholder, but the less profit that can be re-invested back into the company.
A payout ratio of above 100% suggests that the company is sacrificing its balance sheet to support an unsustainable dividend payout. There are only two ways to resolve this situation, either the company increases its earnings or reduces its dividend. Telstra Corporation Ltd (ASX: TLS) finds itself in this position with a payout ratio of 105% at its latest results to 31st December 2016.
A payout ratio of around 80% suggests that the company doesn't think it can grow much organically through re-investing. It is only retaining a fifth of its profit but is being generous to shareholders, this is a sign of a business that has reached maturity and won't grow fast. Businesses like Commonwealth Bank of Australia (ASX: CBA) and InvoCare Limited (ASX: IVC) are good examples of this.
If the ratio is around 50% then it's a good sign that the company is looking for growth and also wanting to reward shareholders. There is usually a good mix of income and capital growth on offer whilst the business is able to re-invest in itself nicely. Good examples of this are Challenger Ltd (ASX: CGF) which has a payout ratio of 49% of its normalised earnings and Ramsay Health Care Limited's (ASX: RHC) ratio of 41.1%.
Finally, there are some companies that keep a big proportion of their profit for generating future growth. Companies such as TPG Telecom Ltd (ASX: TPM) have a payout ratio of 30% and CSL Limited (ASX: CSL) has a payout ratio of 36%. These companies are setting themselves up for long-term growth.
Foolish takeaway
I think any company paying out more than 100% of the profit is asking for financial trouble. The companies that will most likely provide the best total shareholder return over the long-term are ones that keep a decent amount of profit and re-invest it. These three companies are perfect examples of the amazing growth that can be achieved with a sustainable dividend payout ratio.
