How dividend policies generally work

Blog8 - How dividend policies generally work

So, you have bought stocks in a company and have been guaranteed yearly dividend. But do you know how the company’s dividend policy works? As an investor in stocks, it is important to find out how a company’s dividend payout policy works before you purchase its stocks so that you can determine whether it will suite your investment goals.

Generally, the dividend payout policy is determined by the company’s board of directors who make considerations based on a number of factors. This is how dividend policies mostly work.

Investment opportunities available to the company

For companies that are on a growth trajectory, the board will often weigh the pros and cons of paying out a large dividend versus reinvesting this surplus money into available opportunities that will benefit the company’s growth. In most cases, reinvestment usually carries the day because it makes the most sense. However, when it comes to a company that is asset intensive and has a very low return on capital, then the argument to pay out more dividend often makes the most sense.

The level of stability and security of the company’s income statement and balance sheet

All industries will at some point in time experience economic stress. Therefore most companies will always make it a point to have adequate cash reserves specifically for such eventualities. For such companies, as long as their cash reserves are adequate, they will not mind paying out good dividend. However, there are companies with very volatile revenue that will often demand a greater level of management. For such companies, it may not always be wise to payout high dividends to stockholders.

img5 - How dividend policies generally work

The standard industry practice

For a company to remain attractive to capital investors, it will always seek to be within or slightly above the industry standards in terms of its dividend payout policy.

The type of investors the company seeks to attract

A company that seeks to attract investors who are more stable and wealthier will often payoutdividend on amore regular basis as well as ensure it is always growing. In addition to this, strong and sustainable dividend tend to make a company more attractive to investors in the stock market thus driving up share prices. However, for non-dividend paying companies, the result is opposite.

The individual needs of the major shareholders

If paying a high and regular dividend is in the best interest of the major shareholders of the company then you can be guaranteed that the board will always make the decision in this favor and vice versa.

With this knowledge in mind which ideally your broker should advice you on, you will be better placed to know which company’s stocks will benefit you more.

Reach out to us and we’ll guide you on the most appropriate company stocks to suite your investment objectives.

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