ACCA AFM Syllabus A. Role Of The Senior Financial Adviser - Dividends policy - Notes ^{1 / 5}

Investment decision

eg. Think about a young company (such as acowtancy.com)

• All our cash will be used for investments, so our shareholders expect low or zero dividend

• They are happy with that because they think we are fab and cool :) and will grow and their shares will go up hugely in value as we grow

Financing decision

• However, if a company can borrow to finance its investments, it can still pay dividends. 

  This is sometimes called borrowing to pay a dividend. There are legal constraints over a company’s ability to do this; 

  it is only legal if a company has accumulated realised profits.

• Dividend policy tends to change during the course of a business’s lifecycle.

  Young company
  Zero / Low dividend
  High growth / investment needs 
  Wants to minimise debt

  Mature company
  High stable dividend
  Lower growth
  Able & willing to take on debt 
  Possibly share buybacks too

A Residual dividend policy

is a dividend policy company management uses to fund capital expenditures with available earnings before paying dividends to shareholders.

It is appropriate for a small company listed on a small stock exchange and owned by investors seeking maximum capital growth on their investment

A special dividend

is a payment made by a company to its shareholders that the company declares to be separate from the typical recurring dividend cycle.

Special dividends may occur when a company wishes to make changes to its financial structure
 
Usually when a company raises its normal dividend, the investor expectation is that this marks a sustained increase.

• The disadvantage can be that the company could not respond quickly to new business opportunities.

What to look for when considering investing in other company:

1. Are dividends growing at a stable rate?

2. What is the company’s dividend payout ratio ( Divs / PAT)?

   A reduction in dividends paid is looked poorly upon by investors.

3. What is the company’s dividend cover (PAT / dividends)?

4. Are the company’s earnings growing steadily?

5. What happen if profits will fall? Will the dividends be reduced?

   If so, it may cause unnecessary fluctuations of the share price or result in a depressed share price.

6. You should take into account factor such as taxation implications.

Features of an imperfect market impact upon dividend policy:

• Shareholders prefer high dividend payouts as they see these as more secure than capital gains (especially in the current economic environment).

• Dividends are an important source of information. Share price will increase if the dividend is greater than expected and vice versa.

• Shareholder cannot replace a withheld dividend by selling shares, without incurring transaction costs.