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Dividend Payout: This is the dividend paid as a percent of the net income of the firm. If the earnings are negative, it is not meaningful.

a Estimated using S&P 500 data from 1960 to 2003; Source is Bloomberg.

The second widely used measure of dividend policy is the dividend payout ratio, which relates dividends paid to the earnings of the firm.

Dividend Payout Ratio = Dividends / Earnings The payout ratio is used in a number of different settings. It is used in valuation as a way of estimating dividends in future periods, since most analysts estimate growth in earnings rather than dividends. Second, the retention ratio — the proportion of the earnings reinvested in the firm (Retention Ratio = 1 -Dividend Payout Ratio) — is useful in estimating future growth in earnings; firms with high retention ratios (low payout ratios) generally have higher growth rates in earnings than do firms with lower retention ratios (higher payout ratios). Third, the dividend payout ratio tends to follow the life cycle of the firm, starting at zero when the firm is in high growth and gradually increasing as the firm matures and its growth prospects decrease. Figure 10.4 graphs the dividend payout ratios of U.S. firms that paid dividends in January 2004.

Dividend Payout Ratio

a Estimated using Value Line data on companies in January 2004

The payout ratios greater than 100% represent firms that paid out more than their earnings as dividends. The median dividend payout ratio in January 2004 among dividend paying stocks, was about 30 % while the average payout ratio was approximately 35%.

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