Following are the factors that measure the dividend policy of a firm;
Dividend payout rate:
Dividend payout rate refers to the ratio of annual realized total amount of dividends of the enterprise to
realized total amount of net profit. The index directly reflects how many net profits the enterprise can
distribute to shareholders each year, so it is an important indicator judging the dividend policy and for
investors to choose stocks. A higher rate of dividend payment means enterprises dispatch a lot of
dividends every year. A corresponding indicator is retained earnings ratio, which is the ratio of total net
profit the enterprise each year leaves to implemented total net profit every year.
Dividend yield:
Dividend yield index is the ratio of the dividend per share and the stock price of enterprise, which
reflects the earnings that corporate per share can achieve, and is an important indicator when investors
judge investment risk of enterprise.
Dividend Coverage Ratio:
The dividend coverage ratio measures the number of times a company can pay its current level of
dividends to shareholders. A DCR above 2 is considered a healthy ratio. A DCR below 1.5 may be a cause
for concern. Therefore, even a high net income does not guarantee adequate cash flows to fund
dividend payments
Ways and characteristics of dividend payments
Cash dividend:
Cash dividend is a dividend distribution way that the enterprise distributes net profit to the shareholders
in the form of cash. Giving out cash dividend can reduce agency cost, meet the preference of investors
with low-come and transfer information for the future development of enterprises.
Stock dividend:
Stock dividend is a dividend distribution way that the enterprise distributes net profit to the
shareholders in the form of stock. Giving out stock dividend has functions on tax avoidance, reducing
the enterprise shares, diluting share of shareholders and meeting the preference of investors with high come earners, etc.
Why is dividend Policy Important?
A company's yield and dividend strategy are significant considerations considered by many investors
when determining what stocks to invest in. Dividends may help investors achieve a high return on their
investment, and their financial success is reflected in the dividend payment policy of a company. Every
business has a dividend policy, regardless of what they decide to do with their cash. There might not be
a formalization of the dividend program. In addition, internally or externally, it can never be shared. But
if a corporation wishes not to pay a dividend. Or, every year, they chose to pay dividends over the same
months. They have a policy on dividends.
1.
Dividend Policy Provides Information to Investors
2.
Dividend Policy Encourages Management Discipline
3.
Dividend Policy Influences Stock Price and Value
Dividend policy is relevant because the quantity, process, form, and frequency of dividend distributions
are illustrated. This is valid if it is formally specified in the dividend policy. Or, inferred informally.
Sending signals to existing investors and attracting new investors is one of the goals of the dividend
strategy. A sound dividend policy tells an investor what they should expect by investing in the shares of
a company. Also, any time a dividend is declared, it indicates the trust of management in the company's
prospects. A sound policy on dividends builds trust and gives investors’ confidence in their investments.
This means that the business is strong, stable, well-managed and profitable. It promotes long-term
investor participation, not traders. Also, having a dividend policy, requiring the payment of a monthly
dividend establishes a degree of control that must be enforced on management using cash. They realize
that not all cash is available for reinvestment in the company or acquisitions. So, when they allocate
cash, they must choose carefully. Lastly, the dividend policy affects the valuation of the stock of a firm.
Certain methods of stock valuation are solely based on the company's present and expected dividends
paid.
Dividend relevance theory
There are two dividend relevance theories by Walter (1963) and Gordon (1962, 1963), which show that
firms which pay dividend to their shareholders, are considered positively and bear a good image in their
minds. If companies don’t pay dividend then it increases the uncertainty in the eyes of investors and the
payment of dividend increases the share price of firms.
Dividend Irrelevancy Theory:
The dividend irrelevance theory, eminently recognized as Modigliani and Miller’s hypothesis, was
proposed by Modigliani and Miller (1961). In their paper, MM theorized that dividend policy has no
impact on stock price and cost of capital, resultantly the dividend policy of a firm becomes trivial for
shareholders wealth. The results proposed by Pilotte (1992) suggested that firms that distribute more
dividends, usually exhibit less appreciation in stock price. According to MM hypothesis, the sum total of
dividends and capital gains is same regardless of whether the firm distributes more or retains more in
order to receive stock returns via capital gains. Therefore, the investor becomes indifferent. Even when
the dividends are not up to investor’s expectations, however, investors have an option to sell some
portion of their stock to obtain cash, and vice versa.
Optimal Dividend Policy:
Proponents believe that there is a dividend policy that strikes a balance between current dividends and
future growth that maximizes the firm's stock price which is known as Optimal Dividend Policy.