Dividend policy of a company is the decision about the distribution of dividends to its shareholders. Dividend policy is a financial decision that involves deciding on the dividend payout ratio, the frequency of dividends and should they pay dividends at all or not.
The dividend decision of a firm depends on the profits, investment opportunities in hand, availability of funds, industry trends in dividend payment, and company’s dividend payment history.
Profits: Dividend payment is made from the profits of the company. If the company has no profits, then the company won’t be able to pay dividends.
Investment opportunities: If the firm has projects that will lead to the expansion and growth of the company, then the company would prefer retaining back the profits to fund the new projects.
Availability of funds: A firm’s availability of funds impacts the dividend decision. If the firm has enough retained earnings to fund new projects, then they have enough funds to distribute dividends from the current year’s profits.
Industry trends in dividend payment: A company has to keep up with the industry’s dividend payment to survive. Else the shareholders might liquidate their shares in the company to invest in competitors companies.
Company’s dividend payment history: A company that is paying regular dividends tends to keep the dividends stable over the years. They either keep the dividend payout ratio steady or the dividend amount stable.
Following are the four types of dividends that can be a part of a company’s dividend policy:
Cash Dividend: Cash dividends are the most common and popular form of dividend payouts. The company issues a dividend to all shareholders. The cash dividend amount is deposited into the bank account of the shareholder as per their shareholding.
Stock Dividend: Through stock dividend payouts, a company issues additional shares to its common shareholders without any consideration. When a company issues less than 25% of the previously issued stocks, then the dividend is treated as a stock dividend. On the other hand, when the company issues more than 25% of the last issue, it is referred to as stock split.
Property Dividend: A company sometimes issues a non-monetary dividend to its shareholders. The issue of property dividend is recorded against the current market price of the asset issued. The market price of the asset can be either higher or lower than the book value. Therefore, in the company records, the transaction is recorded as either a profit or loss.
Scrip Dividend: In a scenario where the company does not have enough dividend, it may issue a promissory note. A promissory note that is indicating to pay dividends at a later date. Essentially, this creates note payables for the company.
Dividend-paying companies often pay shareholders cash as a percentage of the share price. A cash dividend is a regular cash payment by a company to its shareholders. The money that the company issues as a dividend is often a percentage of free cash that it doesn’t use for any investment.
On the other hand, stock dividends are in the form of more company shares. For example, when a company announces a 10% stock dividend, it means that an investor with 100 shares is eligible to get ten shares as a stock dividend. Therefore, the investor will now have 110 shares.
Cash dividends are taxable. At the same time, stock dividends are subject to tax only when the investor chooses to turn around and sell the extra stocks for cash.
An interim dividend is a dividend that a company pays during the financial year before the company’s Annual General Meeting (AGM) and releasing the financial statements. On the other hand, the final dividend payment is after the declaration of financial results.
Board of directors declares the interim dividend and shareholders declare the final dividend in the AGM.
Retained earnings is the source for paying the interim dividends. Current earnings is the source for paying final dividends.
Interim dividends are related to a part of the financial year, usually six months. Whereas, final dividends relate to the full financial year.
The Board declares interim dividend only when the Articles of Association of the company permits them to. Whereas, final dividends are the right of the shareholders, and there need not be any explicit provision to declare final dividends.
Once the company declares interim dividends, there is no debt obligation on it. The company can cancel the interim dividend after the declaration. However, once the company declares the final dividend, it cannot cancel it. Also, there is a debt obligation on the final dividend.
Dividend-paying stocks are profitable to shareholders in two ways. They offer capital gains through capital appreciation and also additional income through dividends. Also, they provide consistent income through dividends. Dividend-paying companies are usually cash-rich and strong companies that have good prospects for long term performance. Additionally, dividend-paying stocks are less vulnerable to volatility.
Twofold benefits: Dividend-paying stocks offer two-fold benefits to its shareholders. Firstly, shareholders benefit from long term capital appreciation. Secondly, they offer additional income to their shareholders. This also enhances their investment portfolio as the dividend reinvestment can generate more returns.
Consistent income to shareholders: Dividend-paying stocks provide consistent income to its shareholders. This helps them to earn additional income to the shareholders.
Strong companies: Dividend-paying stocks are cash-rich. They are strong companies and have good financials. It also gives confidence to the shareholders about the prospects of the company.Low volatility: Dividend-paying stocks usually belong to sectors whose performance don’t wholly depend on economic cycles. Hence these stocks are less vulnerable to market volatility.
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