Dividends policy

NotesQuizPaper examObjective Test

Dividend policy is mainly a reflection of the investment decision and the financing decision

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
 
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.

NotesQuizPaper examObjective Test