What does the payout ratio indicate about a company's dividend policy?

The payout ratio is a critical metric that indicates the proportion of a company's earnings that is distributed to shareholders in the form of dividends. This ratio is calculated by dividing the total dividends paid by the net income of the company. A higher payout ratio suggests that a significant percentage of earnings are returned to shareholders, potentially indicating a mature company with stable earnings that prioritizes returning capital to its investors. On the other hand, a lower payout ratio may suggest that the company is reinvesting a larger portion of its earnings back into business operations for growth, which can be positive for long-term expansion.

This understanding of the payout ratio is essential for investors who want to assess the sustainability of a company's dividend policy and its approach towards balancing returns and reinvestments.