What can we say about the increase of the dividend payout ratio for a company.Is it...

What can we say about the increase of the dividend payout ratio for a company.Is it a good sign and which is the impact on the free cash flows?

Expert Solution

Dividend payout ratio is a ratio which measures the payment of dividend made by a company. Thus ratio can be found out using the following formula:

Dividend payout ratio(dpr)= dividend per share/ earnings per share

Or

Total dividend paid/ net income

An increase in dividend payout means that the company is distributing more of its earnings to the members. From the perspective of the investor he is earning more for lesser investment. But this also indicates that the company is retaining lesser profits which means that there are lesser profits to invest in growth of the company, payment of liabilities and for other purposes. The company might also be increasing the dpr to increase the share price in the stock market and attract investment. A high dpr therefore, does not guarantee that the company is healthy.

Retained earnings are the profits held back by the company without distributing to its members. And dividends are paid out of the retained earnings. However, free cash flows are the cash flows the company makes through its operating activities reduces by the expenses. Therefore there is no question of divided payout affecting free cash flows of a company.

ekkarill92 answered 10 months ago

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