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Considering Dividend Stocks? Here's All You Need To Know About Dividend Policy

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Considering Dividend Stocks? Here's All You Need To Know About Dividend Policy

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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 get these profits. That's why it is important to know the answers to some basic questions about dividend policy like

-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? 

Dividend policy 101

A company’s dividend policy is a guideline for distributing dividends to its shareholders. These guidelines include the parameters for sharing profits, the frequency of dividend announcements and the shareholder preference while distributing dividends. One important thing to keep in mind while investing in such companies is that not all shareholders get the same dividend.

Every listed company does not need to pay dividends to their shareholders. For those that do payout dividends, there are a couples of factors that serve as an indicator to investors of whether the company is likely to pay dividends or not.

1. 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. 

2. 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 dividend income. 

3. 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. 

4. Dividend trends in the industry

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

Types of dividend

If a company has decided to pay dividends to its shareholders, the next crucial decision it needs to make is the dividend payout ratio. The dividend payout ratio measures how much dividend you can get for each of the shares you hold. It is calculated as 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.  

Companies also need to decide what form of dividend they will payout to shareholders. There are four major types of dividends.

1. Stock dividends 

Dividends can be given in the form of granting additional shares to existing shareholders. 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 surpass this limit.

2. 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 have 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. 

3. Property dividends 

Sometimes, a company issues a non-financial dividend to its shareholders such as property dividend. These dividends can include giving shares of a subsidiary company (another company under a parent brand) as dividends. The value of property dividend is considered against the current market price of the asset. For example, Kaya is a subsidiary of Marico. If Marico gives Kaya’s shares as dividends, they will be called property dividends. 

4. Scrip dividends

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

Apart from these four types, a company might also pay liquidating dividends to its shareholders when it is wrapping up its business to return the capital invested by the shareholders.

Interim and final dividend

A company pays an interim dividend before its profits are declared during its Annual General Meeting (AGM). 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, on the other hand, is paid after the company has declared its financial results. The company’s board of directors declare the interim dividend and final dividend. Companies can pay an interim dividend for part of a financial year (one-two quarters). However, the final dividend is always annual. A company has the right to cancel the interim dividend once announced, but it cannot cancel the final dividend. 

Dividend pattern

A company's dividend policy determines the pattern of dividend distribution.

1. 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. With this type of dividend policy, the company pays shareholders a dividend even if they are making losses. 

2. Regular dividend 

Companies following a regular dividend pattern fix a percentage of their profits to be given as dividends. With a higher profit, the company pays a higher dividend, and a lower dividend when it makes a smaller profit. 

3. Irregular dividend

Here, the company decides to pay a certain amount of dividend to the shareholders on a case-to-case basis. 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. 

4. No dividend

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

Benefits of a dividend policy

A dividend policy will attract investors who are looking for a regular income apart from capital appreciation through stocks. Investors consider companies that offer dividends as cash-rich and stable in terms of business. Shareholders feel confident about the company’s financials on receiving periodic dividend payouts. 

Frequently Asked Questions

1. 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. 

2. 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 is calculated as the annual dividend per share divided by Earnings Per Share (EPS). 

3. 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.

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.
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