Dividend Policy Types Top 4 Most Common Types Of Dividend Policies

Dividend Policy Types

The policy of the dividend distributionPolicy Of The Dividend DistributionDividend policy is the policy that the company adopts for paying out the dividends to the company’s shareholders, which includes the percentage of the amount at which the dividend is to be paid out to the stockholders and how frequent the company pays the dividend amount.read more of a company dictates the number of dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more and the frequency at which the company pays to shareholders. The company can follow different types of policies related to the dividend. When the company earns profits, it has to decide how and where that profit will be utilized. The company can either retain profits earned or choose to distribute the same in the form of dividends to its shareholders.

The four most prevalent types of dividend policy are –

Regular dividend policyStable Dividend PolicyIrregular Dividend PolicyNo Dividend Policy

Let us discuss each one of them in detail –

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Top 4 Most Common Types of Dividend Policies

#1 – Regular Dividend Policy

Under this type of dividend policy, the company follows the procedure of paying 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, it also pays its shareholders a dividend. This type of policy is adopted by the company with stable earnings and steady cash flow. In the eyes of investors, a company paying regular dividends is 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 aim at regular income. The company can only adopt this policy if it has a regular income. The main demerit of this policy is that investors cannot expect an increase in dividends, even if the market is relatively booming. This type of policy helps in creating confidence among the shareholders. It also helps stabilize the market value of shares, which increases the company’s goodwillGoodwill Of The CompanyIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more.

#2 – Stable Dividend Policy

Under this type of dividend policy, the company pays out a fixed percentage of profits as dividends yearly. For example, suppose a company sets the payout rate at 10%. Then this profit percentage 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 dividend rate will be paid out to the shareholdersThe ShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more. 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.

In it, the company makes three components for their dividends. One part is a constant dividend per share, and the other is a constant payout ratio. Last is a stable rupee dividend plus extra dividends. The reserve fund created for this purpose pays a constant dividend per shareDividend Per ShareDividends per share are calculated by dividing the total amount of dividends paid out by the company over a year by the total number of average shares held.read more. The actual company volatility is not verifiable through the dividend payout. The target payout ratio defines a stable dividend policy. It also helps stabilize the market value of shares in the same line as the regular dividend policy.

#3 – Irregular Dividend Policy

Under this type of dividend policy, the company states that it has no obligation to pay 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 concerning paying a dividend has nothing to do with the company’s scenario of earning a profit or coming into a loss. It depends on the decision of the board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more. The board might decide to distribute profit despite having low or no profit. It gains investors’ confidence, and they will invest more in the company, and the company’s liquidity will increase.

In the eyes of Investors Company, paying periodic dividends is considered risky. 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 by using retained earnings. Moreover, companies with irregular cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and a lack of liquidity adopt this policy. The 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 pays no dividend to the shareholders irrespective of its profit or loss scenario. The payout ratioPayout RatioThe payout ratio formula calculates the amount announced as a dividend out of the total earnings (after-tax profits). There are two formulas to calculate the dividend payout ratio using the earning method and the outstanding method. Payout ratio (earning method)= Total dividend paid/Total earning.read more will be 0%. The company will retain the total earnings. It will reinvest into the company’s business model to expand it further with an increased rate and without hurdling into issues like liquidity. The company gets funds through the earnings for shareholders, which is the cheaper cost of financingCost Of FinancingFinancing costs refer to interest payments and other expenses incurred by the company for the operations and working management. An enterprise often borrows money from different financing sources to run their operations in return for interest payments and capital gains.read more, increasing profit.

These policies are adopted by the company that is generally a startup or company (like Google or Facebook) who have already established trust among the investors. For startups, it helps expand 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 company’s growth. 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 bent on a regular income.

Conclusion

In any company, dividends and the dividend policy plays a vital role. Many investors consider this 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 a 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 its financial growth and success.