Dividend payout ratio
This ratio measures the percentage of earnings or net income paid to shareholders in the form of dividends.
An equity investor generates income in two ways: dividends and capital gains. Capital gains are profits that are realised when an investor sells his stock at a price that exceeds the purchase price. For example, if an investor buys a share at USD 10 and sells it at USD 15, he realises USD 5 in capital gains.
A company’s dividend payout ratio tends to depend on its growth characteristics. High-growth companies tend to offer low dividends or none at all, as they will reinvest all of their profits into new projects and investments, in order to generate above average growth. However, stocks of high-growth companies tend to appreciate over time, allowing the investor to realise capital gains. Thus the lack of dividend income is compensated by the potential for capital gains. The opposite is true for low-growth companies.
Shareholders are given solid dividends to compensate for the low potential for the stock’s price to appreciate.