Chartered Financial Analyst (CFA) Level 1 Practice Exam

What does the dividend payout ratio represent?

1. Common share dividends / Net income attributable to common shares

2. FFO / Total debt

3. [CFO - Capital Expenditures] / Total Debt

4. (CFO + Interest Paid) / Gross Interest

The correct answer is: Common share dividends / Net income attributable to common shares

The dividend payout ratio is a financial metric that assesses the proportion of earnings a company distributes to its shareholders in the form of dividends. This ratio is calculated by dividing the total dividends paid to common shareholders by the net income attributable to those common shares. This ratio serves as an important indicator for investors, as it provides insights into the company's dividend policy, financial health, and how much of its earnings are being returned to shareholders versus being retained for reinvestment in the business. A high dividend payout ratio may suggest that a company is prioritizing returning capital to shareholders, while a lower ratio might indicate that a company is reinvesting more of its earnings back into the business for growth or other strategic initiatives. In contrast, the other options relate to different financial metrics that do not pertain specifically to dividends or their payout. For example, funds from operations (FFO) and cash flow from operations (CFO), while important in evaluating a company's cash-generating ability, are not directly related to the calculation of the dividend payout ratio. Thus, the clear focus of the dividend payout ratio on common share dividends in relation to net income attributable to those shares confirms the correctness of this answer.