Stable Dividend Policy

What Is The Stable Dividend Policy?

A Stable Dividend Policy refers to a company's strategy for regularly distributing profits or dividends in a consistent manner in terms of a percentage of earnings or a constant payout.

This makes their distribution independent of the market volatility or "stable," which could be a positive factor when investors decide to invest, as there's a certainty of profits. There are multiple ways a company could distribute its profits: 

1. Regular dividends

The distribution of these dividends is mostly set periodically by corporations as follows:

• Quarterly - Every three months parallel to the company's earnings reports
• Annually - Within 12 months
• Semi-Annually - Every 6 months

Most companies distribute their dividends quarterly. 

2. Irregular dividends

Some companies distribute dividends in irregular patterns as the management sees suited to their business.

3. No dividends

Many companies don't distribute their profits, as the cash reserves can be used in investment opportunities or to grow the business. New companies in their growth phase decide not to distribute their profits as dividends.

Though some companies do not distribute profits in dividends, they are not necessarily a bad investment.

A dividend is a way of distributing profits or rewarding people who have invested in the company. The amount of the dividend and its future growth are decided by the company and its board of directors, usually by calculating long-term earnings when the company reaches maturity. 

Dividends and Dividend Policy

When a company collects profits, it redistributes them to its investors. The portion that each individual investor receives is a dividend. In simple words, a dividend is a share of a company’s earnings given to its stakeholders. 

A company that offers dividends to its investors is considered to be a legitimate and financially healthy company. The primary purpose of a dividend is to attract more investors and to share costs. Some examples of dividends are cash, stocks, shares, and less commonly, properties.

A dividend policy is that policy a company undertakes when deciding how to pay out their dividends to each respective stakeholder. This policy dictates all the terms and conditions of the policy, including the frequency of the payments. It includes three types - residual, stable and constant. Residual dividend policy and constant dividend policy are the most volatile. 

Dividends can only be paid out if the company is profitable. If the company is in losses or even normal profit (zero profit), paying out dividends is not possible. Given that profits aren’t exactly predictable and tend to fluctuate with different factors, dividend payments fluctuate in the same manner. 

When a company shifts away from the implemented dividend policy, it is an extremely important sign to stakeholders. It could either imply that the company is redirecting the funds back into itself, indicative of growth and successful future expansion. However, not adhering to the set dividend policy is often a sign of poor financial well-being, or unforeseen additional expenses. 

While the company often sets the amount of dividend paid out, the disposable income that stakeholders receive is often less than that given out by the company. This is because in most countries dividend income is highly taxed. It is a legal requirement for this dividend income to be reported to the respective tax authority or revenue service. 

Implementation of the Stable Dividend Policy

When a company decides to distribute its profits in dividends, they decide on a policy.

A dividend policy is a way of getting investors to invest in their company, providing an investment opportunity for potential investors. 

The distribution can be majorly divided as

• Distribution in Cash: Company directly transfers the dividends in cash to the shareholders. The board of directors of the company or corporation decides the amount and distribution timings.
• Distribution in Equity: Some companies decide to distribute their dividends in stocks depending on the location and tax policies.

There are multiple ways a company could form the policies:

1. Constant dividend per share

In this policy, a company decides to distribute their dividends in a constant payouts format, for example, ‘x’ USD per share. This policy is much more viable for more stable companies, and their earnings are mature, which allows companies to distribute dividends regardless of their current earnings, i.e., profits or losses.

Example: Let us take company A with 10,000,000$ in quarterly earnings.

In this example, the company provides 5 USD per share regardless of earnings. However, remember that earnings per share don't necessarily need to be higher than the constant dividend per share.

2. Constant payout ratio

In this policy, a business gives out a percentage of its earnings as dividends. The dividends may fluctuate with the earnings but not with the market volatility.

Continuing the same example, company A might also give out a percentage of earnings as a dividend.

Constant payout ratio = 50% ~ 5$

3. Combination of constant dividend per share and constant payout ratio

This policy provides a hybrid between the two giving much more flexibility with the dividends.

A company can decide on a set amount and percentage as a dividend to shareholders. This is a good alternative for companies whose revenue fluctuates significantly each quarter. 

For example, Company A might choose to give out a mixture of both types of dividends, a certain percentage and a fixed amount.

Constant dividend per share = 2$

Constant payout ratio =  30% ~ 3$

Stable Dividend Policy and Target Payout Ratio

An alternative way to define the stable dividend policy is by using a metric known as the Target Payout Ratio. It is most commonly defined as the share of earnings that a company’s board decides to distribute among its stakeholders. 

It is often used by those companies that strive to reach (slowly and consistently) a target payout rate as their earnings rise. This metric is intended for a long-term duration, given that earnings tend to fluctuate in a short period. In simple words, companies often have a target payout they want to eventually reach over months or years. 

For example, a company has a net income of $1 million. Their target payout ratio is 40%. Hence they distribute 40% of their net income, that is $400,000 as dividends to their investors/stakeholders.

A stable dividend policy and a consistent target payout ratio go hand in hand. 

The target payout ratio is based on the company’s preferences, earnings, goals and financial norms. It does not have a generic formula but it does have several different ways of calculating. For example, some companies use Dividend Payout Ratio, whose formula is as given below. 

Dividend Payout Ratio = Total dividends/Total income
Or
Dividend Payout Ratio = Dividends per share/Earnings(income) per share

Others may prefer using previous records and its averages to make their decision on their target payout ratio. Some companies tend to base their target payout ratio and stable dividend policy based on the amount of financial capital they need for reinvestment. 

Companies must keep maintaining a stable dividend policy and a consistent target payout ratio, as a priority. This is due to the following reasons: 

1. Attractive to stakeholders and future investors - Having a stable target payout ratio paints an image that the particular company is reliable, and successful. This prompts the interest of various stakeholders. 

2. Industry comparison - Having a set target payout ratio gives an idea on where the company stands in its industry. It allows for easy comparison with its competitors. This enables the company to identify where it’s lacking and how to improve their standing in their market. 

3. Financial planning - A consistent target payout ratio and stable dividend policy allows for better financial and capital planning. It enables better allocation of resources that maximises profits and efficiency.

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