DIVIDEND PAYOUT RATIO

Description: This ratio is used by investors to determine whether a company is generating a sufficient level of cash flow to assure a continued stream of dividends to them. A ratio of less than one indicates that existing dividends are at a level that cannot be sustained over the long term.

Formula: Divide total annual dividend payments by annual cash flow. If there is a long standing tradition by the board of directors of continually increasing the amount of the dividend, then annualize the last (and presumably largest) dividend only and use the resulting figure in the numerator of the calculation. The formula is:

Example: The Williams Fund is a major investor in the Continental Gas and Electric Company. The Fund is controlled by the Williams family, whose primary concern is a long-term, predictable flow of cash from its various investments. The family is concerned that electricity deregulation may be affecting the ability of Continental Gas to pay dividends. It has collected information about Continental for the past three years, shown in Table 4.9.