Understanding the concept of dividends and dividend policy is very important to investors. In this article, we explain what dividend policy is, the different dividend policies, and how the policies work.
What Is A Dividend?
We can refer to a dividend as an earning which is distributed to shareholders. The percentage of profits paid as dividends is called the payout ratio. A high payout ratio means higher dividends and fewer funds for expansion. A lesser payout results in growth.
What Is A Dividend Policy?
A dividend policy is a policy in which an organization uses to organize its dividend payout to its shareholders. The legal framework within which you can pay dividends in Nigeria are:
- So long as it will not lead to a reduction in the company’s capital
- If it will not make it unable to pay its debts as at when due
- If we need not pay only losses from the previous year in the current year
How Do These Policies Work?
They are an income for shareholders, despite the suggestion that it is irrelevant. The company’s board of directors are often the largest shareholders and have the most to benefit from an abundant dividend policy.
Types of Dividend Policy
There are four main types, and we can summarize each of them to help you understand them better:
- Regular Dividend Policy
- Stable Dividend Policy
- Irregular Dividend Policy
- No Dividend Policy
- Residual Dividend Policy
1. Regular Dividend Policy
This enables the company to follow the procedure of paying out a dividend to its shareholders yearly. The payment of the dividend is made whether the company was profitable for the year. This type of policy is embraced by organizations with stable earnings and cash flow, especially blue chip companies.
2. Stable Dividend Policy
This enables the company to follow the procedure of paying out a stipulated fixed percentage of profits as dividends yearly. This fixed percentage of profit will be paid as dividends annually, regardless of the measure of profit.
3. Irregular Dividend Policy
Under this type of scenario, the company has no obligation regarding paying a dividend to the respective shareholders yearly. The board of directors will decide the amount and rate of the dividend when they see fit (usually yearly). They will decide regarding the steps to be taken with the profit made in each year.
4. No Dividend Policy
Under this type, the company pays no dividend to the shareholders regardless of its profit or loss of a particular year. The company will keep the total profit to reinvest into the business and to expand it further.
5. Residual Dividend Policy
With this, the company only pays out what dividends remain after the company has paid for all other expenses, debts, and working capital. This approach may be strained, but it makes the most sense in terms of any business operational structure.
Whether dividends will increase, the value may depend on the profitable investment opportunities available to the firm. If the firm has profitable opportunities, its value will be maximum when 100% of earnings are retained.
All of this depends on the company valuation.