As an employee of a firm you are entitled to get a good bonus amount only if your firm is profitable throughout the year but on the contrary, if the firm is not doing good, then you miss your bonus. In the same way, a Dividend is that bonus that a listed company gives out to its owners when the company is doing well. Dividend refers to that portion of the profit that is distributed among the owners or shareholders of the firm who have their skin in the business. Dividend payout is determined by the dividend policy guidelines of the company. The dividend policy is the framework governing the dividend payout of the company to safeguard shareholders’ interest and to ensure the future growth of the company. Factors affecting dividend policy will be discussed further in detail.
What is a Dividend Policy?
The company’s decision of paying out a dividend or retaining the surplus profits will depend upon the dividend policy. The dividend policy answers the below questions:
When – During which time period should the company payout the dividend?
How – How much should be the dividend payout ratio?
Should it pay dividends or reinvest the profits?
How often should the dividend be paid by the growing company?
How to safeguard shareholders’ interests through dividend policy?
The dividend policy answers all the above questions in-depth with all the details. Thus, this policy becomes vital for both the company as well as for the shareholders. Thus there are different types of dividend policies curated to meet the specific needs of the company. Likewise, various factors affecting dividend policy make dividend policy extensive and detailed. On preference shares, the dividend is paid at a predetermined fixed rate. The decision of dividend on equity shares is not mandated and it lies with the company every year.
Factors affecting Dividend Policy Objectives of Dividend Policy
The company formulates a dividend policy keeping in mind various factors affecting it. Below are some of the objectives of framing a well-detailed dividend policy:
The above objectives are declared keeping in mind the factors affecting dividend policy.
Dividend policy should be analyzed in terms of its effect on the value of the company.
There is an opportunity cost involved if the company distributes its surplus profits in the form of dividends to its shareholders or invest that money on a new venture to create more value in the long run.
There is a trade-off between the dividend, financing, and investment decisions of any company.
Dividend decisions will not have a short-term impact but a long-lasting impact.
Dividend policy should be compliant with the financial planning of the company.
Dividend policy should be clearly communicated to all the stakeholders to ensure transparency.
Erratic and frequent dividends should be avoided.
There are various factors affecting the dividend policy of any company like below:
What are the Factors affecting Dividend policy? Capital Requirement of the company
If the company requires huge capital consistently then the dividend policy might be stringent with no frequent dividend payouts. As the surplus profit will be reinvested as capital into the business. On the other hand, if the company has no recurring capital requirement then the dividend policy might be framed to pay out regular dividends.
Stability of Earnings
If the company’s earning is consistent or stable, like a company selling groceries, medical supplies where the sales remain stable throughout the year, the dividend policy will suggest consistent dividend payouts. This policy is also known as a stable dividend policy. On the contrary, the companies dealing in seasonal products or services like raincoats, or winter clothes will experience sales fluctuations. Thus, they will not have a stable dividend policy.
Liquidity of funds
With sufficient liquidity of funds, the company has a free hand in declaring dividends. A company with a liquidity crunch will not be able to payout dividends consistently.
The Companies investing in numerous projects typically retain profits to finance investments and are less likely to pay dividends. There is always an opportunity cost involved when the company has the option to invest the profits or pay out dividends.
Age or Tenure & Size of the Company
Large, mature & tenured companies tend to pay higher dividends than companies that are growing and consolidating in the market. It is because tenured large companies have already established their brand and earnings have become more stable. Whereas small and relatively new companies are still trying to create a place for themselves in the market and they rely heavily on internally generated funds to fund capital requirements or investments.
Nature of the business
Depending upon the nature of industry and business the dividend policy might provide for generous dividends, erratic dividends, or stable dividends. The companies dealing in FMCG, Pharmaceutical sectors usually provide stable dividend policies. Those dealing in fertilizers, textiles have non-consistent dividend payouts.
A closely held business with a lesser number of shareholders makes it easy for the company to have a flexible dividend policy. Whereas widely held businesses with a large number of shareholders will demand a rigid policy with consistent and higher dividends.
Share Holding Legal restrictions
Legal restrictions may limit the number of dividends that a company pays. Thus net asset and current ratio constitute important determinants of dividend payout. Government policies to maintain liquidity and solvency ratios will affect the company’s ability to pay out dividends. Contractual liabilities should be fulfilled before paying dividends to shareholders.
Higher taxes may reduce the company’s dividend payout. Dividend tax will impact a company’s dividend policy.
If the company is able to repay its loan, then surplus profits will be used to pay dividends. Companies with reduced debt or no debt will have a stable dividend policy. The company with higher loans will have to follow the debt covenants imposed by the lender. As per the negative debt covenant, it might restrict the company from distributing its profits in the form of dividends to its shareholders till the time the debt is paid off.
Debts repayments Control of Business
If the company wants better control over the management and ownership, it may declare lower dividends to keep the investors out.
Inflation affects dividend decisions. If inflation is increasing year on year, the company has to decide how much to distribute as dividend and how much to reinvest. Higher the inflation rate, lower probability of dividend payout.
Above the dividend payout factors affecting the dividend policy are taken into consideration when deciding on dividend payouts.
When the dividends are paid out consistently as per below then the policy may be called a stable dividend policy
Factors affecting Dividend Policy What is a Stable Dividend Policy?
A stable dividend policy is usually adopted by large, well-established, and tenured companies with stable earnings. These companies have the ability to declare stable dividends to the shareholders and maintain their trust. This policy develops a strong bond and trust between the shareholders and the company since the shareholder’s interest is safeguarded. It’s always good to invest in the stock of such companies with a stable dividend payout policy.
As an investor, you would love to get passive income apart from capital appreciation in the market price of the stocks in which your money is invested. Now it’s important to understand the very nature of the business, the tenure, demand and supply fluctuations, the impact of inflation or uncertainties, investment opportunities, and other factors affecting the dividend policy of the firm as it would directly impact the dividend income due to you. Thus invest in a company with a good track record of dividend payout ratio, yet fundamentally sound with growing demand for its products or services in near future. Stay away from those stocks which offer very high dividend payout ratios but are fundamentally weak, as reflected in their financials. Choose a fundamentally strong yet company with a great value proposition reflected in its financial figures, trends, and its offerings. You need to be patient and stay invested in the company selected as the prices will swing and so will the dividend payout ratio due to the factors affecting dividend policy.
Stable dividend per share
Stable percentage of net earnings
Dividends as a fixed percentage of market value
Global dividends are forecast to rise to $1.39 trillion this year, a strong recovery with a growth of 26.3% in the second quarter, as per the data from the investment manager’s Global Dividend Index.
Let us know which factors affecting dividend policy have impacted your investment decisions?