In the modern business environment, talks about negative payout ratio and dividend policy illustrate how companies go about spending their excess cash, reward shareholders and lay out the foundation for commercial success. For a cash-strapped organization, these discussions may introduce a volatile element in an already combustible situation, especially if equity holders and lenders differ over who should first receive payments once the business turns its operations around.
A company's payout ratio represents how much, percentage-wise, it doles out as dividends at the end of a given period -- such as a month, quarter or fiscal year. For example, a business reaps net income of $1 million at year-end, and management decides to pay aggregate dividends amounting to $250,000. Consequently, the organization's payout ratio is 25 percent, or $250,000 divided by 1 million. In the global marketplace, there often is a compelling operating rationale for maintaining high payout ratios and increased levels of share repurchase transactions. This is because these moves tell the public the dividend-paying company is financially healthy.
A payout ratio cannot be negative, conceptually and mathematically speaking. Conceptually, a company is less likely to dole out money to stockholders if it posts a net loss at period-end or has experienced a losing streak over several quarters or years. Such a business may inch closer to the "companies fearing bankruptcy" list than the "healthy organizations paying dividends" category. Mathematically, the payout ratio formula calls for a positive numerator -- that is, net income -- and not a negative number.
Investors sift through the payout policy of a recently bankrupted company to understand strategies and tactics top leadership has set to run a tight ship, with a special focus on how senior executives intend to reward shareholders who came to the organization's rescue by pouring fresh money in its operations. Still fearful of post-bankruptcy disorder, financiers may be patient and give company principals a break, as long as they show a clear path to commercial success and chart a credible road map to compensate shareholders down the road. Generally speaking, companies with a high payout ratio are more likely to attract securities-exchange players, as they see the ratio as a vigil for economic soundness and can reap rosy returns on their investments.
Calculating payout ratios and using the metrics for dividend policymaking call for specific skills. These run the gamut from business acumen and analytical dexterity to investment flair, attention to detail and being good with numbers.
- Business Dictionary: Payout Ratio
- Rutgers University; Optimal Payout Ratio under Perfect Market and Uncertainty: Theory and Empirical Evidence; Cheng-Few Lee, et al.; February 2010
- New York University Stern School of Business; Determinants of the PE Ratio; Aswath Damodaran
- University of Maryland Smith School of Business; Financial Management (PDF); Dividend Policy
- "Dividend Policy Decisions"; Itzhak Ben-David; May 2010 (PDF)
Marquis Codjia is a New York-based freelance writer, investor and banker. He has authored articles since 2000, covering topics such as politics, technology and business. A certified public accountant and certified financial manager, Codjia received a Master of Business Administration from Rutgers University, majoring in investment analysis and financial management.