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Payout Ratio

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The payout ratio, sometimes called the dividend payout ratio, is the percentage of a company's earnings that it pays out as dividends. If a company has yearly earnings of $10 and pays $2 in dividends, its payout ratio is 2/10, or 20%. Generally, mature companies with few growth opportunities have a high payout ratio, because returning earnings to shareholders represents the best use of profits. A rapidly expanding firm, however, often has a low payout ratio, because it uses the cash instead to invest in businesses with high growth potential. A firm's payout ratio reflects its need to offer investors a satisfactory return on their investment, which comprises both capital appreciation and cash dividends. Investors in expanding firms often enjoy substantial capital appreciation and thus are satisfied even when the payout ratio is zero. Mature firms have fewer expectations of high growth to drive their stock price, thus they satisfy investors with large dividends and a high payout ratio.



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