The payout ratio is the proportion of a company's earnings paid to shareholders as dividends, expressed as a percentage of net profit (or, alternatively, of EBITDA). A company paying €400,000 of dividends on net earnings of CHF 1 million has a payout ratio of 40%. The retention ratio (1 − payout ratio) is the fraction of earnings reinvested in the business. The payout ratio is a key parameter in the Gordon-Shapiro formula — the higher the payout ratio, the higher the dividend paid but the lower the sustainable growth rate, since less is reinvested.

The Gordon-Shapiro relationship between the payout ratio (p), growth (g), and the return on invested capital (ROIC) is: g = (1 − p) × ROIC. A company paying out 100% of earnings has zero retained earnings to fund growth and can only grow if it raises external capital. A company retaining 60% (p = 40%) with a ROIC of 15% achieves a sustainable growth rate of 9%. This relationship is critical for calibrating the terminal value in a DCF: an unrealistically high growth rate combined with a high payout ratio implies the company is growing faster than its retained earnings allow.

In a valuation context, the payout ratio also affects the tax efficiency of different distribution strategies: in Switzerland, dividends from participations qualifying for the participation exemption flow tax-free at the corporate level, but are subject to the 35% withholding tax and cantonal income tax at the individual level. Comparing dividends vs. salary vs. capital reduction as distribution mechanisms requires analyzing the payout ratio in a total after-tax return framework.

At Hectelion, we model the optimal payout ratio and distribution strategy in our structuring and valuation mandates for Franco-Swiss owner-managed companies.