How to interpret a stock which can give a stable dividend policy?

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The moment college ends and the reality of making ends meet kicks in, what we all start aspiring for is stability. We believe that stability brings success and vice-versa. We work hard to ensure a stable income so that we can fulfil our needs as well as wants. Such is the outlook for investors of companies that employ a stable dividend policy. 

While we look for stability in our incomes, why not look for stability when it comes to growing our income? Investing may not only reap you long-term benefits but can also provide a regular periodic income by the means of dividends.

Now, you may wonder if dividend distribution varies, how can one rely on that? There is a profitable policy that some companies follow which is known as the stable dividend policy. Many shareholders prefer this policy as it leads to stable dividends rather than fluctuating ones. 

A stable dividend policy implies that the dividend is distributed regularly even though the amount may fluctuate over the years irrespective of the volatility of the markets. Think of this as the volt guard installed in the homes that protect our gadgets from teetering voltages. Imagine a day without the cool breeze of the A.C. just because the fluctuation of the volt blew the fuse. Much like this, a stable dividend policy weathers your needs and protects your investment returns from market fluctuations. 

Before we understand how to choose and invest in shares that offer a stable dividend policy, let’s first comprehend the stable dividend policy fully.

So, what does a stable dividend policy mean ?

The stable dividend policy aims to ensure that there is a predictable as well as steady dividend payout, something that most investors cherish. Irrespective of an increase or decrease the investors would continue to receive dividends. 

This policy tries to ensure that dividends are distributed every quarter, however, they may be paid out either annually or semi-annually. This policy has been most aspired because it means that shareholders will remain certain that they would receive a dividend payout at least once a year. 

How does this work?

To put it simply, every year the company sets a benchmark to distribute a portion of the profit accumulated to its shareholders through dividends. These are mature companies which do not envision any strong growth strategy. 

How is a stable dividend policy implemented?

Constant payout ratio:

This type of distribution is preferred by most companies, this is when the predetermined per cent of the profits is disbursed amongst the shareholders. 

Constant dividend per share:

If a company follows this it means that they distribute a fixed amount of cash dividends. A reserve is created which then facilitates a fixed dividend payout even if the company suffers losses. This is practised by companies whose income has been stable over a long period.

A combination of the above two:

Along with a fixed dividend payout the company also disburses an additional dividend which is in line with the earnings of the company. This is ideal for companies whose earnings are in constant flux. 

We’ve now understood the stable dividend policy in depth, however, how do we know we are investing in a share that offers us this advantage.

How to identify shares with a stable dividend policy?

Before purchasing a share of any company it is vital to do some research and gauge various ratios and parameters. Unfortunately, companies do not explicitly disclose the dividend policy they employ, you have to read through the annual reports to determine the result. What has been disclosed in these reports is the dividend payout ratio.

The dividend payout ratio indicates how much of a company's earnings after tax (EAT) is distributed to shareholders. The dividend policy of a company is measured by employing the dividend payout ratio (DPR).

DPR = dividend per share (DPS) / earnings per share (EPS)

Dividend payments indicate that a company is profitable enough to share a portion of its profits with its shareholders, boosting shareholder trust in the management team. This ratio provides insight into the company's goals and allows us to assess the company's maturity.

For example, if a corporation is in its early stages of development, the dividend distribution may as well be zero. This is the effect of reinvesting earnings in the firm to stimulate future growth.

As a result, expanding firms that pay a large percentage of their net income in dividends are frequently a red flag for investors. Because increased dividend payments imply less cash to finance development projects, the stock price of such a corporation would eventually fall.

Companies that pay high and reliable dividends are often ones that have already matured and have little opportunity for further expansion.

How to evaluate DPR?

It is important to monitor a company’s dividend payment to get some insight into the company’s dividend policy. If you notice that a company’s DPR rises over time that means that the company is heading towards maturity and has healthy and stable operations. However, if there are spikes in the DPR this would show that the company may have problems in ensuring long-term high dividends.

When a company’s DPR exceeds 100%, which indicates that the company does not have a long-term sustainable strategy, companies employ this strategy to lure investors and avoid selling stock. Therefore, to determine if the company employs a stable dividend policy it is important to track changes in the DPR over some time.

Summing it up:

Many companies have different approaches to dividend disbursement, their suitability depends on the type of industry. Additionally, the policy of dividends also speaks volumes about a company’s confidence. A progressive dividend payout indicates a bullish outlook. Investors have several ways to monitor the dividend and evaluate the business, but monitoring the DPR over the long term will give the investor an accurate picture of dividend disbursement, likewise into the stable dividend policy of the company as well. While understanding how to invest money in the share is fairly exhausting at least the actual investing bit can be made easier by using the seamless Fi app for mutual fund investments. 

Frequently Asked Questions:

What is a stable dividend policy example?

The percentage of profits given out as dividends is predetermined under the stable dividend policy. If a company's payout rate is fixed at 12 per cent, for example, that proportion of earnings will be paid out regardless of the number of profits produced during the financial year. 

What is a stable dividend policy and its merits?

A stable dividend policy is where an investor receives dividends at least once a year irrespective of market fluctuations.

  • It helps to keep the market value of stocks stable.
  • It instils confidence in investors.
  • It provides a source of income for those investors who rely on dividends to cover their day-to-day costs. 

Which dividend policy is best?

The simplest and most widely utilised dividend policy is a stable dividend policy. The policy's purpose is to provide a consistent and predictable dividend distribution year after year, which is what most investors want. Investors receive a dividend regardless of whether earnings are up or down.

What are the 4 types of dividend policy?

A regular dividend policy comes first, followed by an irregular dividend policy, a stable dividend policy, and no dividend policy.

How can the stability of dividend policy be maintained?

The corporation pays out a set amount of cash dividends each year. It then establishes a reserve that enables them to pay a fixed dividend even if earnings are low or losses occur.

For whom is the stable dividend policy best suited?

This policy is ideal for those who are not merely looking for capital appreciation but also are looking for a steady income source.

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