How is the Payout Ratio defined?

The Payout Ratio is a financial metric that shows the proportion of earnings a company is willing to distribute to its shareholders in the form of dividends. It is calculated by taking the cash dividends paid per common share and dividing that by the earnings per share (EPS). This ratio is significant for investors because it provides insight into how much of the company's profit is being returned to shareholders versus how much is being retained for growth or reinvestment. A high payout ratio might indicate that a company is prioritizing returning cash to shareholders, while a low ratio could suggest that it is reinvesting its earnings for future growth.

In contrast, other options do not relate to the definition of the Payout Ratio. Net income divided by average equity pertains to the calculation of Return on Equity (ROE), which measures a company's profitability relative to shareholders' equity. Gross profit divided by net sales indicates the Gross Margin, which assesses a company's production efficiency and pricing strategy. Lastly, net sales divided by total assets is reflective of the asset turnover ratio, measuring how efficiently a company utilizes its assets to generate sales. These concepts are important, but they do not pertain to the Payout Ratio itself.