Dividend payout policies are one of the most essential decisions which a company needs to make. This is mainly because there are quite a number of factors which may affect the payout policy of a given company and thus an organization needs to be keen. These factors may include Repurchasing Shares and the different types of dividends models. Before understanding what Dividend payout policies, it is necessary that we first define this common term.
Definition of Dividend Payout Policy
Dividend policy of a company is the plan followed in order to determine the timings of payments and total amount of dividends. Dividend policy of a company just like other policies is subject to various challenges which may make it under perform. Some of the most common factors which frame a dividend policy include:
- Availability of better investment opportunities.
- Flotation Costs
- Financial flexibility
- Estimated volatility of future earnings
- Tax considerations.
These are just some of the factors which frame a dividend policy of any given policy.
Types of Dividend Payout Policies
There are basically three typos of depending policies which are arrived at based on the frequency and amount of the dividend pay-outs:
Stable Dividend Policy
Stable Dividend Policy is the most common type of Dividend Policy since it aims at achieving a standout payout every year. This is made possible since it does not reflect short term earnings volatility in the pay-outs. Therefore, shareholders may sometimes find it hard when it comes to predicting the future dividends’ level.
Stable Dividend Policy contains two possibilities which may sometimes be taken as real. These possibilities are:
- Dividends may fail to rise at the same rate of earnings in the most profitable years.
- Dividends may sometime rise even during the period when earnings of a company seem to be declining.
Because of these possibilities, a Stable Dividend Policy may start moving towards a Target Payout Ratio. What this means is that the policy gradually moves towards a strategic goal which showcases the share earnings of the company. By doing so, a company is able to distribute the earnings in form of dividends to shareholders over a long-term.
Constant Dividend Policy
Under the Constant Dividend Policy, a certain percentage of the company’s earnings is given out as dividends each and every year. However, the volatility of Short-Term earnings tends to affect the dividends and thus it varies directly with the company’s earnings. Unfortunately, the Constant Dividend Policy is not common in companies.
Residual Dividend Policy
With Residual Dividend Policy, a company is expected to pay the dividends using funds left after deducting capital expenditures of the current period. This expenditure is usually deducted from the funds which a company generates internally. You should therefore be ready to put into consideration Target Capital Structure, Cost of Capital and Investment opportunity Schedule of a company when using this policy.
Dividend Payout Policy is an important factor which is used as valuation for the company. Furthermore, any signal that an investor interprets during the various changes in dividend payments also affects the stock price of your company. It is therefore advisable that analysts examine the impact of various dividends together with share repurchases on the stock.