Ask the Fool

Payout Ratios, Explained

Q: Can you explain payout ratios? — M.W., Bradley, Illinois

A: A company’s payout ratio is the percentage of its earnings (net income) that’s paid out to shareholders as dividend income. For example, PepsiCo’s trailing earnings per share (EPS) over the past year were recently $5.05 and its annual dividend was $4.02 ($1.023 per quarter). Divide $4.02 by $5.05 and you’ll get 0.80, or a payout ratio of 80%.

A payout ratio above 100% reflects a company paying out more than it’s earning, which is not sustainable over the long run. (It can be OK in the short term, if the company is going through a temporary rough patch.) A high payout ratio — say, 80%, 90% or more — gives a company little flexibility regarding what it can do with its cash. That can be OK for big, established companies that don’t need to reinvest much in their businesses. A low payout ratio reflects lots of room for dividend increases.

Consider a very steep payout ratio a red flag, as the company may have to reduce its dividend. For lists of our recommended stocks, with and without dividends, check out one of our investor services, at Fool.com/services.

Q: How many stock mutual funds exist? — R.P., Beaverton, Oregon

A: According to the Investment Company Institute, as of November 2020, there were about 7,677 mutual funds in the U.S., with about 4,478 of them focused on stocks. It’s worth counting exchange-traded funds (ETFs), too, as they’re also pooled money invested in portfolios of various securities. As of November, there were 2,165 ETFs, 1,634 focused on stocks.

To learn more about investing in mutual funds and ETFs, visit Morningstar.com or the “Investing Basics” nook at Fool.com.