The payout ratio can be found by:
Dividend per share / Earnings per share
While increasing dividends over time will cause the share price to increase, it is important that companies do not pay out too much of the earnings as dividends.
Dividend payout should not be excessive, especially for high growth companies
Let us examine an example here. A company earns $3 per share and pays out $2.90 per share in dividends. Effectively, it only has $0.10 per share to reinvest into fixed assets. In a case like this, the company’s management may be destroying value over time at the expense of a high payout ratio. High growth companies normally do not pay out much in dividends. They reinvest the earnings to grow its earnings per share.
Mature companies normally pay out a dividend. One must be able to make sure that an adequate portion of its earnings is reinvested to maintain its profitability.
How option traders can make use of the payout ratio?
Option traders who want to invest in high growth stocks can check the payout ratio to make sure that the company is not paying too much of its dividends in such a way as to stifle growth. Slow growth stocks or mature companies may have a fair dividend payout but may grow slow. For mature and slow growth companies, option traders can use neutral to mildly bullish strategies.