GLOSSARY // Fundamentals
Payout Ratio
The payout ratio is the share of earnings a company pays out as dividends: dividends per share divided by earnings per share. A company earning $5.00 and paying $2.00 has a 40% payout ratio.
It is the dividend's safety gauge. Below ~60%, the payment is comfortably covered and there is room to raise it; above 80%, a modest earnings dip forces a choice between the dividend and everything else; above 100%, the company is paying out more than it earns, funding the gap with debt or cash reserves — sustainable only briefly.
REITs are the exception by design: they must distribute at least 90% of taxable income to keep their tax status, so their payout ratios are evaluated against funds from operations (FFO) instead of EPS.
A company earns $5.00 per share and pays $2.00 in annual dividends: payout ratio = 2 / 5 = 40%. If earnings fall 30% to $3.50 in a recession, the unchanged dividend now consumes 2 / 3.50 = 57% of earnings — still covered, which is exactly the cushion a 40% starting ratio buys.
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Educational only — not financial advice. Definitions simplified for clarity; markets are messier than definitions.