There are four types of dividend policy. First is regular dividend policy, second irregular dividend policy, third stable dividend policy and lastly no dividend policy. The stable dividend policy is further divided into per share constant dividend, pay-out ratio constant, stable dividend plus extra dividend.
Dividend Policy Types
The policy of the dividend distribution of a company dictates the number of dividends and the frequency at which the company pays to shareholders. When the company earns profits, it has to decide regarding how and where that profit will utilize. The company can either retain profits earned or else they can choose to distribute the same in the form of the dividends to its shareholders. There are different types of policies related to the dividend which the company can follow.
Four most prevalent types of dividend policy are –
- Regular dividend policy
- Stable Dividend Policy
- Irregular Dividend Policy
- No Dividend Policy
Let us discuss each one of them in detail –
Top 4 Most Common Types of Dividend Policies
#1 – Regular Dividend Policy
Under this type of dividend policy, the company follows the procedure to pay out a dividend to its shareholders every year. If the company earns abnormal profits, then it retains the extra profit. Whereas, if it remains in loss any year, then also it pays a dividend to its shareholders. This type of policy is adopted by the company who are having stable earnings and steady cash flow. In the eyes of investors, a company paying regular dividends are low risk despite the fact the quantum of regular dividend might be small. Under this policy, the investors get dividends at a standard rate.
The class of investors putting their investments into these companies is generally risk-averse. They mainly belong to the retired or weaker section of the society and aims at regular income. This policy can be adopted by the company only if it has a regular income. The main demerit regarding this policy is that investors cannot expect an increase in dividends, even if the market is relatively booming high. This type of policy helps in creating confidence among the shareholders. It also helps in stabilizing the market value of shares, which increases the goodwill of the company.
#2 – Stable Dividend Policy
Under this type of dividend policy, the company follows the procedure to pay out a defined fixed percentage of profits as dividends every year. For example, suppose a company sets the payout rate at 10%. Then this percentage of profit will be paid out as dividends every year regardless of the quantum of profit. Whether a company makes a profit of $1 million or $200000, a fixed rate of dividend will be paid out to the shareholders. In the eyes of investors, a company adopting this policy is risky. The reason being the amount of dividend fluctuates with the level of profit.
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In it, the company makes three components for their dividends. One part is a constant amount of dividend per share, and the other part is a constant payout ratio. Last is a stable rupee dividend plus extra dividends. The constant dividend per share is paid through the reserve fund created for this purpose. The actual company volatility is not verifiable through the dividend payout. The target payout ratio defines a stable dividend policy. It also helps in stabilizing the market value of shares in the same line as regular dividend policy.
#3 – Irregular Dividend Policy
Under this type of dividend policy company states that it has no obligation in respect of paying a dividend to the shareholders. The board of directors will decide the quantum and rate of dividend. They will decide in respect of action, taken with the earned profit. Their action in respect to paying a dividend has nothing to do with the company’s scenario of earning a profit or coming into the loss. It depends on the decision of the board of directors. The board might decide to distribute profit despite having low or no profit. It gains the confidence of investors, and they will invest more in the company, and the company’s liquidity will increase.
On the other hand, the company might retain all or significant amounts of profit and distribute no or fewer dividends. The company may do this to increase the growth of the company by using the retained earnings. Moreover, this type of policy is adopted by the company who are having irregular cash flow and lacks liquidity. In the eyes of Investors Company, paying irregular dividends is considered risky. Class of investors who are risk lovers prefers investing in this type of company.
#4 – No Dividend Policy
Under this type of dividend policy, the company follows the procedure of paying no dividend to the shareholders irrespective of its profit or loss scenario. The payout ratio will be 0%. The total earning will be retained by the company. It will reinvest into the company model of business to expand it further with an increased rate and without hurdling into issues like liquidity. The company gets funds through the earning for shareholders, and it is the cheaper cost of financing, increasing profit.
These types of policies are adopted by the company that is generally startup or company (like Google, Facebook) who have already established trust among the investors. For startups, it helps in expanding their business, which will result in the overall growth of the business. The shareholders invest in the company’s following no dividend policy with the aim that their total value of an investment will increase with the growth of the company. For them, appreciation in share price is more important than the regular dividend. The class of investors investing in these companies generally belongs to younger or middle ages that are not more bend towards regular income.
Conclusion
In any company, dividends and the dividend policy plays a vital role. Many investors consider this as an essential factor while deciding whether they should invest in the stocks of a particular company or not. Dividends help the investors to earn a high rate of return on the investment done by them. The dividend payment policy of the company is the reflection of the financial performance of the company. Thus the company should choose the dividend policy that it will be following correctly as it is critical to the company’s financial growth and success.
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