Income Investing: Alternative Dividend Policies
In order to survive, companies always find ways to construct plans that will help to maintain their present condition. As these companies make some progress, they continually feel the need to give back to their shareholders in order to preserve their trust while continuing their business operations and pursuing other projects in the future.
A dividend is a percentage of a company’s retained earnings that are distributed to the shareholders in a form of cash, shares of stock, or property. Every time a company earns largely for a year, the shareholders are being paid back by the company through disbursing dividends as a reward for investing in them.
Most companies pay cash dividends to the shareholders. Even though, the dividends are not distributed periodically. The board of directors decides the right time to pay back to the shareholders and the portion of the retained earnings that shall be appropriated for the dividend distribution. Their dividend decisions are influenced by different factors to consider such as the company’s outstanding debts, liquidity position, inflation, legal restrictions, and earnings stability.
Dividend policy is the financial strategy that the board employs to build its dividend payout to shareholders. The concerns that are included in the dividend policy are the payment timing and the amount which are based on the long-term capability to earn and on the unappropriated retained earnings. The understanding of shareholders from the dividend policy is essential from the fact that the dividends to be received by them will be coming from the unappropriated retained earnings.
This article aims to enumerate the year-to-year patterns on how companies construct the structure of their dividend payout and explain the rationale behind these.
Constant Dividend Payout Ratio
Under this policy, it is specified that a fraction of retained earnings is constantly taken for dividend distribution every year. In short, the constant dividend payout ratio preserves the percentage of retained earnings distributed as dividends to the shareholders annually. Despite the stability of the dividend per earnings ratio, short term earnings’ volatility still affects the dividends. The amount of dividends expectedly varies every year as profits fluctuate. In spite of this, most of the companies do not use this policy.
Constant dividend payout policy appears to be adaptable to weakening market status as the dividend per share directly changes as the earnings fluctuate. The policy does not manifest any disapproving indication from the fact that the dividend payout ratio is not volatile. As a result, investors can be enticed by the companies that use this policy.
In this policy, the fairly steady dollar dividend is sustained every period despite the earnings’ volatility. A specific amount is given per year as dividends which depends on the management. The amount per dividend will not fluctuate unless the board is persuaded by data that an increase in dividend payment will guarantee the maintenance of its value in the future. The dividend per share will not decrease as long as the management can still anticipate the longstanding strength of a current dividend.
A stable dividend policy indicates a constant normal operation of a company and steadies the market value of shares. In addition, a company’s liquidity position gets better. As a result, it can meet the standards of the investors that are looking for stable dividends. The continuous dividend distribution is advantageous for investors. It strengthens the relationship between the shareholders and the company because the dividends have become a regular source of income. This policy is beneficial for retirement as the stable dividend distribution can be financial support to suffice someone’s daily necessities.
Even with the advantages of applying a stable dividend payout, companies also face risks that can cause severe damages which explains the refusal of companies on its usage. The companies that frequently pay out dividends without considering their financial standing seem undesirable for potential investors. It will also result in the disposal of shareholders of their stocks.
Small, Regular Dividend Plus Year-End Extra Dividend Payout
Applying this dividend policy will let companies distribute dividends periodically and reward shareholders with year-end additional dividend during their successful times. This policy is different from regular paying dividend policies because extra dividends are announced unexpectedly. Most companies pay out large amounts of cash as an extra dividend that is why the board meticulously assesses the company’s condition to avoid complications in the future.
After evaluating the company’s profits for that year, the extra dividends will be declared at the end of the fiscal year. The reason why companies impose this policy is to prevent the implication of long-lasting dividends. Issuing extra dividends also indicates a good management strategy. Another purpose of paying out extra dividends is to prove to shareholders how successful the company is and that it will maintain its financial health over a long period of time which might result in gaining the confidence and loyalty of the investors for the company.
The small regular dividend plus year-end extra dividend payout is applicable for cyclical companies that are largely affected by economic fluctuation. The profits of these companies are volatile. Therefore, there are times that dividend distributions are postponed due to losses or capital expenditures from other periods that they are still currently working out. Utilizing this policy has a drawback as well. It is a mistake for the companies to pay out extra dividends to its shareholders while erroneously expecting that they can support their future projects. Investors may perceive it as a bad corporate decision made by the board.
The company might miss the chance to capitalize on new projects or facilities because it already had paid out extra dividends to the shareholders taken from the company’s cash. On the other hand, companies may seem to be inactive in making new projects because they are distributing extra dividends plus small regular dividends. A company must obtain reinvestment opportunities as well from the fact that growth is also an important concern for investors.
Some investors do not prefer investing from companies that are exploiting the small regular dividend plus year-end extra dividend payout because of its unpredictability. These companies may look as if they prosper just because of some special incidents and not because of their efforts to stabilize their financial condition. Companies exert every effort to disburse dividends consistently over the long-term future. Nonetheless, some instances require them to prioritize other aspects.
