Wednesday, 10 April 2019

What dictates dividend policy?

Management determines if it is going to 

  • distribute earnings in the form of a dividend or 
  • reinvest all earnings to further the business plan of the company. 

The ratio of dividends paid out to investors versus the amount of earnings retained is called the payout ratio.  

The Dividend Decision

Changes in tax law and investor preference can influence decisions in the corporate boardroom regarding how much profit to retain or to pay out to investors in the form of dividends.  

However, dividend increases often lag behind an increase in earnings because management will want to be certain that a new higher dividend payment will be sustainable going forward.

Change in Dividend Yield has a lot to do with change in Share Price

Looking back over market history, we can see that dividend policy and payouts have remained relatively steady and that any change in dividend yield has had a lot more to do with the change in stock prices than with changes to dividend policy made by corporate directors.  (Note:  You can 'price' your stocks by looking at historical dividend yields.)

A cut in dividends is often perceived negatively

Management is usually very reluctant to reduce dividends because a cut is often perceived as a sign of financial weakness.  

Even during the Great Depression, companies were loath to cut dividends.  
  • From 1929 to 1932, dividend yields soared because most companies maintained their dividends as stock prices collapsed in the crash.  
  • But, as stock prices rose from 1933 to 1936, dividend yields fell - even though companies were actually increasing the dividends they paid.

This inverse relationship between dividend yield and price was really evident during the huge bull market run from 1982 to 1999.  
  • Companies increased dividends steadily over the period, actually increasing dividends paid by almost 400 percent.  
  • Yet the dividend yield collapsed to historic lows because stock prices increased by 1,500 per cent.

Some companies do run into trouble and cut or omit their dividend payments, but this is the exception rather than the rule. 

The typical dividend-paying company

The typical dividend-paying company not only maintains the dividend payout it establishes, but follows a policy of steadily increasing its dividend as earnings increase. 

Some companies increase their dividend payments 
  • (1) every quarter, 
  • (2) some once per year, and 
  • (3) others only as profits allow.

Some companies will even pay extra or special dividends if earnings have been quite good for a number of years.

Dividend policy

Many established public companies pay cash dividends and have a dividend policy that is well known to their investors.  

Some of them have been paying cash dividends for a very long time.

1 comment:

Anonymous said...

The main determinant of dividend policy, all things being equal, is how shareholder-friendly the company management is.