Dividend Policy - Meaning, Types, Factors, Objectives and more

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If you have purchased ownership of a company by investing in its stocks, you are eligible to get a part of the company’s profits through dividends. 

The dividend policy of the company you’ve invested in will determine how you will get these profits. 

Therefore, it is important to know the answers to the following basic questions about dividend policy:

  • What is a dividend policy?
  • What are the types of dividend policies?
  • What are the objectives of a dividend policy? 
  • What are the factors affecting dividend policy? 

Let’s answer the questions above through a detailed discussion on these topics. 

What is a dividend policy?

A company’s dividend policy is a guideline for distributing dividends to its shareholders. These guidelines include aspects like the parameters for sharing profits, the frequency of dividend announcements and the shareholder preference while distributing dividends. Yes, not all shareholders get the same dividend or even get a dividend. 

  • What does a dividend decision depend on? 

Every listed company does not need to pay dividends to their shareholders. The following are the factors affecting the dividend policy of a company:

  • Profitability

A company will declare a dividend only if it has made a profit. The company’s profits also determine the proportion of dividends distributed among the shareholders. 

  • Dividend payment history 

Generally, a company with a history of paying dividends to its shareholders keeps its dividend amount stable. These are dividend stocks where most investors park their money to earn stable dividends. 

  • Growth plans and availability of funds

A business might retain its profits if it has plans to reinvest them to expand its business. However, if the company's retained earnings are enough to fund its expansion, it may decide to pay dividends. 

  •  Dividend trends in the industry

To retain their shareholders, companies might match the dividend trends that exist in their industry. 

How do companies decide on dividends?

Once the company has decided to pay dividends to its shareholders, it needs to decide on the following questions:

  • What is the dividend payout ratio?

One of the major dividend policy decisions is about the dividend payout ratio. 

The dividend payout ratio of a company is the annual dividend per share divided by the (EPS) or Earnings Per Share. EPS is a figure that describes the profit amount per share of the company. The dividend payout ratio measures how much dividend you can get for each of the shares you hold. 

  • What is the type of dividend to be paid?

Four major types of dividends are stock, cash, property and scrip. Let us learn about each of them in detail: 

  • Stock dividends 

These are additional shares given to the shareholders as dividends. A company can issue less than one-fourth of its previously issued stock in stock dividends. However, if the company is providing additional shares in the form of a stock split, it can issue more shares than one-fourth of its previous issue. 

  • Cash dividends

In cash dividends, the company pays a fixed amount per share to its shareholders. For example, if the dividend rate is 5% and you are holding 100 shares of the company, your cash dividend value would be 5 x ₹100 = ₹500. 

Cash dividends are more popular than other forms of dividends in India. 

  • Property dividends 

Sometimes, a company issues a non-financial dividend to its shareholders. This property dividend is considered against the current market price of the asset. These dividends can also include giving shares of a subsidiary company (another company by the same parent brand) as dividends. These companies are independent but are partially controlled by the bigger brand or a parent company. 

For example, Kaya is a subsidiary company of Marico. Therefore, if Marico gives Kaya’s shares as dividends, they will be called property dividends. 

  • Scrip dividends

A scrip dividend is a promissory note that a company issues to its shareholders when it does not have enough dividends. This promissory note indicates that the company will pay dividends to its shareholders later. These dividends are usually cash dividends promised to pay later. 

Apart from these four types, a company might also pay liquidating dividends to its shareholders. 

When a company is wrapping up its business, it might return the capital invested by the individual investors. These dividends are called liquidating dividends. 

  • What is the difference between interim and final dividends?

How does a company know that it is making a profit? They know this by analysing their performance through their financial statements. 

Here are the points of comparison between the interim and final dividend: 

  • Time of declaration

A company pays an interim dividend before its profits are declared in the Annual General Meeting (AGM). The final dividend, on the other hand, is paid after the company has declared its financial results. 

  • Who declares it?

The company’s board of directors declare the interim dividend, and the shareholders declare the final dividend. 

  • What is distributed?

Companies distribute interim dividends from their retained earnings. A company's retained earnings are the amount of profit left after paying direct and indirect costs and taxes. The final dividend is declared based on the company’s current earnings.

  • Period of distribution

Companies can pay an interim dividend for part of a financial year (for one or two quarters). However, the final dividend is always annual.

  • Choice of cancellation

A company has the right to cancel the interim dividend once announced, but it cannot cancel the final dividend. 

  • What type of dividend pattern does the company follow? 

The dividend distribution pattern differs from company to company. These patterns determine the types of dividend policy of a company. The following are the popular patterns followed by companies:

  • Stable dividend

In this pattern, shareholders receive a fixed dividend amount from time to time. This stability in distributing dividends is unaffected by the earnings of the company. In a stable dividend, the company would pay shareholders a dividend even if they are making losses. 

  • Regular dividend 

Companies following a regular dividend pattern fix a percentage of their profits to be given as dividends. Therefore, with a higher profit, the company pays a higher dividend, and with a lower profit, the company pays a lower dividend to the shareholders. 

  • Irregular dividend

Here, the company decides to pay a certain amount of dividend to the shareholders solely based on their decision. The company decides on dividends as per its priority. For example, if the company plans to expand, it might reinvest its profits and decide not to pay dividends. 

  • No dividend

A company following a no dividend policy retains all its profits and does not distribute them among its shareholders. 

What are the benefits of a dividend policy? 

While stock investments are better for earning through long-term capital gains, getting a periodic dividend can add to the benefits of investing. 

Here are the benefits shareholders can get from a company’s dividend policy: 

  • Dual benefits

The shareholders can make dual gains by investing in stocks, one from the capital gains and another from dividends. 

  • The periodic realisation of profits

You earn profits by redeeming or selling your shares after a certain period. By getting dividends, you can realise some of the profits of your shareholding periodically without selling the stocks.

Here are the benefits a company can get from a well-defined dividend policy:

  • Investor trust

Investors consider companies that offer dividends as cash-rich and stable in terms of business. Therefore, the shareholders feel confident about the company’s financials on receiving periodic dividends. 

  • Attracts new investors 

A few investors invest in shares solely to earn a regular dividend. For these investors, stocks of a dividend-paying company are more attractive than other stocks. 

To conclude 

The dividend policy of a company is a fundamental guideline that can determine its profit distribution style. This policy determines whether or not a firm will pay dividends. And, if the company chooses to pay dividends, what will be its form and distribution period. 

Frequently asked questions

  • What is a dividend policy and its factors?

A company's dividend policy is a guideline to determine the type, period and pattern of distributing dividends. 

The factors that impact a company’s dividend policy are profitability of the company, availability of funds, growth plans, dividend history of the company and dividend trends in the industry. 

  • What is the formula of a dividend policy?

The dividend policy is used to decide on the dividend payout ratio of a company. The dividend payout ratio of a company = annual dividend per share divided by Earnings Per Share (EPS). 

This formula can help you determine how much returns per share you will receive from your investment.

  • What are the benefits of a dividend policy?

The dividend policy equally benefits the company and the shareholders in the following ways: 

For companies:

  • Shareholders exhibit more trust in the company that pays periodic dividends over a non-dividend paying company. 
  • Regular dividend payments attract investors who want to invest in robust businesses and earn a steady income through dividends.
  • Paying periodic dividends throws good light on the financials of the company. 

For shareholders:

  • The dividend policy clearly and transparently states the terms of dividend distribution between the shareholders and the company.
  • Shareholders of a dividend stock can earn dual income.
  • By having period dividends distributed, the shareholders can be confident about the company’s financials.
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