CandleFocus Glossary Editor
A company's dividend policy can have a major effect on its stock market value, future growth potential, and financial structure. Dividends refer to the amount of profits a firm pays out to its shareholders. Dividend policies are a set of guidelines that the company uses to decide how much of its profits will be paid out as dividends. These policies typically address factors such as when to pay dividends, how and how much to pay, and how to adjust the dividend payments over time.
Stable dividend policy is when a company pays dividends out of its earnings at steady or constant ratios, for example 25% or 50% of its earnings distributed as dividends. Stable dividend payouts are often preferred by investors, as they indicate consistent cash flow and comforting levels of financial stability and thus company performance. The downside to a stable dividend policy however, is that if the company’s earnings suddenly increase, it may need to distribute dividends that are too low to generate an attractive return.
Constant dividend policy is when a company chooses to maintain a specified percentage of its earnings as dividends, regardless of its performance. In theory, a company with a constant dividend policy will have to resort to its reserves to tide over low growth periods and thus reducing the payout to shareholders during these times. This can be beneficial in protecting shareholder interests, however, it can potentially limit the firm’s growth potential because a portion of the earnings will always be diverted to shareholders.
Residual dividend policy is less common than the two other dividend policies and involves a calculation of how much profit the company has left to distribute as dividends after the firm has reinvested in future growth. With this policy, a company will evaluate how much resources it needs to reinvest in its operations and will then distribute the remaining profits as dividends. This dividend policy typically works best for companies with high growth potential because it ensures that the necessary resources will be reinvested for future development.
Ultimately, investor’s decisions on whether or not to buy a particular company's stock is based on its dividend policy since they can measure the possible returns they will receive if the company continues to offer stable payments in the future. Understanding a company's dividend policy is certainly important, as it can provide a clearer outlook in terms of the company's future performance. Accordingly, the dividend policy of a company is always monitored by investors.
Stable dividend policy is when a company pays dividends out of its earnings at steady or constant ratios, for example 25% or 50% of its earnings distributed as dividends. Stable dividend payouts are often preferred by investors, as they indicate consistent cash flow and comforting levels of financial stability and thus company performance. The downside to a stable dividend policy however, is that if the company’s earnings suddenly increase, it may need to distribute dividends that are too low to generate an attractive return.
Constant dividend policy is when a company chooses to maintain a specified percentage of its earnings as dividends, regardless of its performance. In theory, a company with a constant dividend policy will have to resort to its reserves to tide over low growth periods and thus reducing the payout to shareholders during these times. This can be beneficial in protecting shareholder interests, however, it can potentially limit the firm’s growth potential because a portion of the earnings will always be diverted to shareholders.
Residual dividend policy is less common than the two other dividend policies and involves a calculation of how much profit the company has left to distribute as dividends after the firm has reinvested in future growth. With this policy, a company will evaluate how much resources it needs to reinvest in its operations and will then distribute the remaining profits as dividends. This dividend policy typically works best for companies with high growth potential because it ensures that the necessary resources will be reinvested for future development.
Ultimately, investor’s decisions on whether or not to buy a particular company's stock is based on its dividend policy since they can measure the possible returns they will receive if the company continues to offer stable payments in the future. Understanding a company's dividend policy is certainly important, as it can provide a clearer outlook in terms of the company's future performance. Accordingly, the dividend policy of a company is always monitored by investors.