Dividend Policy

What Is a Dividend Policy?

A dividend policy is the policy a company uses to structure its dividend payout to shareholders. A few specialists recommend the dividend policy is irrelevant, in theory, since investors can sell a portion of their shares or portfolio on the off chance that they need funds. This is the dividend irrelevance theory, which gathers that dividend payouts negligibly influence a stock's price.

How a Dividend Policy Works

Notwithstanding the idea that the dividend policy is irrelevant, it is income for shareholders. Company leaders are much of the time the biggest shareholders and have the most to gain from a liberal dividend policy.

Most companies view a dividend policy as an indispensable part of their corporate strategy. Management must settle on the dividend amount, timing, and different factors that influence dividend payments. There are three types of dividend policies — a stable dividend policy, a consistent dividend policy, and a residual dividend policy.

Types of Dividend Policies

Stable Dividend Policy

A stable dividend policy is the simplest and generally regularly utilized. The goal of the policy is a consistent and unsurprising dividend payout every year, which is what most investors look for. Whether earnings are up or down, investors receive a dividend.

The goal is to adjust the dividend policy to the long-term growth of the company instead of with quarterly earnings volatility. This approach gives the shareholder more certainty concerning the amount and timing of the dividend.

Steady Dividend Policy

The primary drawback of the stable dividend policy is that investors may not see a dividend increase in boom years. Under the steady dividend policy, a company pays a level of its earnings as dividends consistently. Along these lines, investors experience the full volatility of company earnings.

In the event that earnings are up, investors get a bigger dividend; assuming earnings are down, investors may not receive a dividend. The primary drawback to the method is the volatility of earnings and dividends. It is hard to plan financially when dividend income is exceptionally unpredictable.

Residual Dividend Policy

Residual dividend policy is likewise profoundly unpredictable, yet a few investors consider it to be the main acceptable dividend policy. With a residual dividend policy, the company pays out what dividends stay after the company has paid for capital expenditures (CAPEX) and working capital.

This approach is unstable, however it checks out in terms of business operations. Investors would rather not invest in a company that legitimizes its increased debt with the need to pay dividends.

Illustration of a Dividend Policy

Kinder Morgan (KMI) stunned the investment world when in 2015 they cut their dividend payout by 75%, a move that saw their share price tank. In any case, numerous investors found the company on strong balance and pursuing sound financial choices for their future. In this case, a company cutting their dividend really helped them out, and six months after the cut, Kinder Morgan saw its share price rise practically 25%. In mid 2019, the company again raised its dividend payout by 25%, a move that assisted with reviving investor confidence in the energy company.

Features

• Stable, consistent, and residual are the three types of dividend policy.
• Even however investors realize companies are not required to pay dividends, many think of it as a bellwether of that specific company's financial wellbeing.
• Dividends are many times part of a company's strategy. Be that as it may, they are under no obligation to repay shareholders utilizing dividends.