Dividend Yield vs Payout Ratio: Two Denominators, Two Answers

Both put the same dividend on top. The yield divides it by the share price; the payout ratio divides it by earnings. For Sankalp Industrial Systems Limited, invented, in Year 0, Rs 3.60 of dividend is a 4.00 per cent yield against a price of Rs 90.00 and a 52.17 per cent payout of Rs 6.90 of earnings. Only one of the two moves when the market opens.

The split in that last line is the whole of the matter, and it is worth slowing down on. Two measures share a numerator and disagree about nothing. The two measures still answer questions of completely different kinds, and the reason sits underneath each of them. Earnings per share is something the company produced and reported. A share price is something a stranger paid this morning. Put the same rupee over each and the result is not two versions of one number; it is two numbers.

What is actually different between the two?

Consider a shop on a busy street that made Rs 10,00,000 last year and handed Rs 4,00,000 of it to the people who put up the money. Asked what share of the year's takings went out of the door, the shopkeeper answers four tenths, and that answer does not change no matter who walks past. A different question: someone is offering to buy the whole shop for Rs 80,00,000, and the question is what that Rs 4,00,000 looks like against that asking figure. Now the answer depends on the offer, and the offer changes with the mood of whoever is offering.

The payout ratio is the first question and the dividend yield is the second, and the difference between them is entirely in the denominator. Nothing about the dividend changes. Nobody disagrees about what was paid. The two measures simply stand the same payment against two different things, and one of those things belongs to the company while the other belongs to a market.

What does the payout ratio measure?

The payout ratio takes the dividend for a period and divides it by the earnings for the same period. For Sankalp Industrial Systems Limited, Year 0 closed with profit attributable to ownersThe bottom line once the lenders have taken interest, the tax charge has gone, and the outside holders of the part-held unit have had their share of it. of Rs 1,38,00,00,000 spread across a share countThe divisor under any per share figure: how many shares stand in issue when a profit is spread across them. of 20,00,00,000 shares. The division gives Rs 6.90 of earnings per share. The board declared a regular dividend of Rs 2.60 per share and, on top of it, a special dividendA distribution the board separates from the usual line in its own announcement, so that the repeating amount and the running total can be told apart afterwards. of Rs 1.00, making Rs 3.60 in all.

Both rows are payout ratios for Year 0 and both are correct. The two rows answer different questions: the first row is about the part that repeats, the second about everything that left the company.

The same two figures can be reached without touching a per share line at all, and doing so is a useful check. The regular dividend cost Rs 52,00,00,000 in total and the special one cost Rs 20,00,00,000, so Rs 72,00,00,000 went out against profit of Rs 1,38,00,00,000. The aggregate figures give 37.68 and 52.17 per cent again. The check never reached outside the accounts. A payout ratio therefore exists for every year a business has reported figures at all.

The five year run for this company is below, and every row of it is arithmetic on two reported figures.

The ratio column is a sequence of board decisions. The first four years sit in a narrow strip a little under four tenths. Year 0 jumps, and the jump is entirely the Rs 1.00 special. With the special stripped out, Year 0 reads 37.68 per cent, back inside the strip. The measure is doing its job: it states what proportion of a year's earnings was handed over, and nothing else.

What does the dividend yield measure?

The dividend yield takes the same dividend and divides it by the share price. Sankalp Industrial Systems has shares that are listedTraded under the rules of an exchange, which is also what brings the disclosure conditions below into play., and its Year 0 price is locked in the record at Rs 90.00. Set the regular Rs 2.60 against that price and the result is 2.89 per cent. Set the full Rs 3.60 against it and the result is 4.00 per cent on the nose.

The aggregate check works here too, and it is worth doing once because it shows what the yield really is. Twenty crore shares at Rs 90.00 puts the whole equity at Rs 18,00,00,00,000. Against that, the Rs 72,00,00,000 of total dividend is 4.00 per cent, and the Rs 52,00,00,000 of regular dividend is 2.89 per cent. So a yield is the cash a company handed to its shareholders measured against what the whole of that equity was changing hands for. The yield states what one rupee spent on a share got back in cash over that period, and it is therefore a statement about a price as much as about a company.

The sentence required has just changed. The payout ratio needed a period. The yield needed a period and a price, and a price needs a day. Rs 90.00 was true on one day, and the record does not claim it was true on any other. The extra requirement is small to write down and it changes everything about how the figure behaves.

Why are there four numbers for one year, and how can all four be right?

Two dividends and two measures give four figures, and a reader meeting them for the first time usually assumes three of them must be wrong. All four are correct. Each answers a different pairing of question and dividend.

A bare percentage attached to this company is unusable: four of them exist for one year and the reader cannot tell which one arrived. A figure of 4.00 per cent and a figure of 52.17 per cent are both about Year 0 and both about Rs 3.60, and they are more than thirteen times apart. Nothing in either number announces which one it is.

Now look at what the extra Rs 1.00 did. On the yield it took 2.89 to 4.00, a move of 1.11 percentage pointsSubtract one percentage from another and this is the unit that is left. A percentage point answers a different question from asking how much one of the two grew.. On the payout ratio it took 37.68 to 52.17, a move of 14.49 points. One rupee, two moves, and the second is 13.04 times the first. The multiple of 13.04 should look familiar in a moment.

How do the two connect to each other?

The two measures are not merely related. One is the other divided by a third figure, and the third figure is the price to earnings ratioHow many rupees of share price sit on each rupee of a year's earnings. The ratio is written as a number of times rather than as a percentage.. For this company in Year 0 that ratio is Rs 90.00 over Rs 6.90, or 13.04 times. Multiply a yield by it and the price disappears.

Run it on both rows of the grid and it holds exactly. On the regular dividend, 2.888889 per cent times 13.043478 is 37.681159 per cent, the payout ratio to the last digit shown. On the total, 4.000000 per cent times 13.043478 is 52.173913 per cent. The identity is not approximate here and it is not approximate anywhere; it is what the algebra says.

A small trap sits in that sentence, and it catches most readers eventually. Walking into it on purpose costs a minute and saves the mistake. Take the two figures as printed here, 2.89 per cent and 13.04 times, and multiply them. The product is 37.69 per cent, not 37.68. The same on the total row, 4.00 times 13.04, gives 52.16 rather than 52.17. Nothing has gone wrong with the identity. Both inputs were rounded for display before they were multiplied, so the product carries both roundings and lands one hundredth off. The rule that avoids it is short: work the arithmetic on the full figures, round the answer rather than the inputs, and treat a printed figure as a display of a number rather than as the number itself.

Turn the identity around and it earns its place. If a yield is a payout ratio divided by a price to earnings ratio, then a yield can move for three separate reasons. The dividend changed. Earnings changed. Or the price changed. The first two are the company doing something. The third is not the company at all, and the yield reports all three in the same figure without labelling which one is at work.

Why does one of them move when nothing at the company has changed?

Hold the dividend at Rs 3.60 and hold earnings at Rs 6.90. The board has gone home; nothing about Year 0 will ever change again. Now let the price wander. A price is what the last buyer and the last seller agreed on, and there is a new one every few seconds.

At Rs 60.00 the yield is 6.00 per cent. At Rs 72.00 it is 5.00. At Rs 80.00, 4.50. At Rs 90.00, 4.00. At Rs 100.00, 3.60. At Rs 120.00, 3.00. Across that whole run the payout ratio reads 52.17 per cent, six times over, without moving a hundredth. A yield can halve while the company's decision about its profit stays exactly where the board left it.

The same split shows up outside a company altogether. Suppose a household rents out a room for Rs 8,000 a month and never changes the rent. The share of the rent that goes on the room's upkeep is fixed by what the household spends, and no news about property prices touches it. The rent measured against what the flat would fetch today is a completely different figure, and it changes every time somebody down the road sells. Same rent, two figures, one of them at the mercy of a market. The two rent figures are the yield and the payout ratio, wearing different clothes.

The record has a price for one year. What breaks?

One thing becomes visible only when both measures are built across the whole history, and it is the sharpest way to feel the distinction between them. The record for this company locks profit, share count and dividend per share for five years. The record locks a share price for one year only: Rs 90.00, in Year 0. There is no Rs 90.00 equivalent for Year minus 1, or for any year before it.

So the payout ratio column runs the full five years, and the yield column has four holes in it and one figure. Three of the four figures at work here come off the statements, and the fourth needs somebody to have written down what a share changed hands for on a particular day. The holes are not a defect in the record. The holes are what the two measures actually are.

The grey cells are not a company that paid nothing. Every one of those years paid a dividend and every one has a payout ratio sitting directly above it. The missing figure is a price, and without a price the division simply cannot be performed. The asymmetry is worth carrying. A payout ratio is available wherever accounts are available, including for a company whose shares nobody quotes at all. A yield exists only where somebody has recorded a price and stated which day it belongs to.

Which measure answers which question?

There is no default. The question decides, and the questions are genuinely different, so a reader who picks by habit picks wrong about half the time.

The third row is the question almost every reader actually came with, and neither measure answers it. A payout ratio of 37.68 per cent and a yield of 4.00 per cent are both divisions performed on figures from a period that has closed. Nothing inside either arithmetic reaches forward. Whether a dividend can be paid again depends on the earnings the company goes on to make and on what the board decides to do with them, and neither of those is in either fraction.

What does a usable sentence have to carry?

Everything above collapses into one working rule, and it is short enough to keep. Name which dividend went on top, and date the price that went underneath. A sentence carrying both is checkable by whoever reads it. A sentence missing either one is not, however correct the number in it happens to be.

Two settings anchor the range. At the default setting, Rs 90.00 with the total dividend, the panel reads 4.00 per cent against 52.17 per cent, exactly the Year 0 pair printed above. At either end of the scale the payout ratio still reads 52.17 per cent while the yield reads 6.00 per cent at Rs 60.00 and 3.00 per cent at Rs 120.00. With the regular dividend selected, the payout ratio holds at 37.68 per cent across the whole range while the yield runs from 4.33 to 2.17 per cent.

Stare at the last column for a moment. Twelve different yields sit to the left of it, produced by six prices, and it holds one figure per dividend the whole way down.

What does neither measure say?

Both figures are divisions performed on a period that has closed. A closed period rules out most of what people want from the two measures, and the whole list is easier to take in one go than one disappointment at a time.

A payout ratio and a dividend yield are both descriptions of something finished, and neither carries a claim about what happens next. The moment a reader treats 4.00 per cent as a rate they will keep receiving, they have added a promise that the arithmetic never made. The promise is the reader's addition, and it is the single most common thing that goes wrong with these two measures.

How do people who are not writing about these two actually use them?

An analyst covering this company builds the payout ratio first and the yield second, and for a reason worth copying. The ratio is the one that can be put in a row across five years without a single missing cell, so it is the one that shows a pattern: 37.50, 38.46, 39.29 and 38.10 per cent, then a jump to 52.17 that is entirely one special. Everything the analyst wants to ask about the board's habit lives in that row. The yield gets computed once, for whatever day is being written about, and gets rewritten every time the note is refreshed. One of these two figures belongs in the permanent part of a file and the other belongs in the part that is restamped.

A lender reads neither figure the way a shareholder does. A dividend is cash leaving before the lender's own claim gets any thicker, so what the lender wants from the payout ratio is the complement: with 37.68 per cent going out on the regular dividend, roughly six tenths of the year's earnings stayed inside. The retained portion funds the next stretch of growth without new borrowing. Sankalp Industrial Systems has a cost of capitalThe blended annual return the money financing a business has to earn before anything is left over for the people who supplied it. Built and settled under the weighted average cost of capital. of 12.00 per cent, and the question of whether the retained portion clears that charge is a different subject entirely. The lender simply notes how much is being kept.

Somebody who holds shares directly reads the yield, and reads it correctly only if they hold the second clause in their head. A purchase at Rs 90.00 makes a Rs 3.60 dividend 4.00 per cent of the price paid. A purchase at Rs 120.00 makes the same Rs 3.60 worth 3.00 per cent of the price paid. The company did nothing different in the two cases. The two purchase prices differ, so the two yields differ. Two households paying different rents on identical flats are not disagreeing about anything either.

And the household example travels further than it looks. A shopkeeper who has been putting aside two fifths of the year's profit for the people who funded the shop knows the payout ratio without ever using the phrase. Nobody quotes a price for the shop on a Tuesday, so that shopkeeper has no yield. The payout ratio is the measure that exists for every business; the yield is the measure that exists only where somebody is quoting a price. The record gap drawn four years wide in the table above arrives here in a form anybody can feel.