Dividend Payout and Earnings Retention

As we have seen in various places, a firm's net income gets divided into two pieces. The first piece is cash dividends paid to stockholders. Whatever is left over is the addition to retained earnings. For example, from Table 3.3, Prafrock's net income was $363, of which $ 121 was paid out in dividends. If we express dividends paid as a percentage of net income, the result is the dividend payout ratio:

Dividend payout ratio = Cash dividends/Net income = $121/$363 = 33Va%

Retention ratio = Addition to retained earnings/Net income = $242/$363

You can find growth rates under the research links at finance.yahoo.com.

What this teils us is that Prufrock pays out one-third of its net income in dividends.

Anything Prufrock does nol pay out in the form of dividends must be retained in the firm, so we can define the retention ratio as:

So, Prufrock retains two-thirds of its net income. The retention ratio is also known as the plowback ratio because it is, in effect, the portion of net income that is plowed back into the business.

Notice that net income must be either paid out or plowed back, so the dividend payout and plowback ratios have to add up to 1. Put differently, if you know one of these figures, you can figure the other one immediately.

Payout and Retention

The Manson-Marilyn Corporation routinely pays out 40 percent ol net income In the form of dividends. What is Its plowback ratio? II net income was $800, how much did stockholders actually receive?

If the payout ratio is 40 percent, then the retention, or plowback, ratio must be 60 percent since the two have to add up to 100 percent Dividends were 40 percent of $800, or $320,

Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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