Do companies consider these factors to declare dividend?

DO COMPANIES CONSIDER THESE FACTORS TO DECLARE DIVIDEND?

Background

Dividend strategy of a company, more particularly which is widely held, should be such that the needs for funds within the company are satisfied and also the reasonable expectations of the investing public/ share capital providers are met.  Hence, a good course of action should strike a balance between the outgo on account of dividend, and, retention of funds as internal accruals of a company.       

{ I } Types of Dividend

1. Regular and stable Dividend.

In this case a sustainable level of dividend is set and the same is raised only when the company can keep up higher quantum. Hence, this level forms the base of the dividend payouts. Efforts should be made to maintain this level or a higher quantum to give stability and regularity to the dividend payouts. However, in the event of adverse situations at any time the dividend may be cut, but, this is not advisable since a reduction in dividend imparts unfavorable impact in the Stock Market.

2. Constant pay out based on earnings.

In this case dividend is paid equal to a constant percentage of the earnings of the company.  Where there is a volatility in the earnings, the dividend may also fluctuate in a unpredictable manner which is not advisable.

3. Multiple increase in dividend. 

Here, small and frequent increases in the dividend are done by the company to show that there is a movement and growth in the company. The signal of frequent dividend increases is expected to have positive impact in the Stock Market.

4.  Regular and extra dividend.

In this case, the dividends are bifurcated into two portions.  A regular dividend and an extra dividend. The regular dividend is the one that is expected to continue from year to year and the extra dividend will be as per the financial position/performance of each year.  The extra dividend may be paid by way of interim dividend before the final dividend.

{ II } Factors which may be considered for Dividend strategy

Need for funds by the Company.

Where there is long term plans for growth, the company may follow the conservative dividend policy.  This will ensure that the profits are retained in the company for future growth.  Where the company does not have any major future plans, the liberal dividend rule may be followed.

Where the company needs to raise fresh resources from the investors in the market through issue of shares/securities, it is necessary that dividend expectations of the investors are reasonably satisfied.

Stability of Earnings.

If earnings are relatively stable, a company is then able to better predict what will be its future earnings.  Hence, there is likelihood to make higher dividend payout as compared to another company with fluctuating earnings.  Such company with unstable earnings is not certain what its earnings shall be in future, so it is more likely that it shall retain a higher proportion of its earnings.

Liquidity

In order to pay dividend, a company requires cash and therefore, the availability of cash resources within the company will be a determining factor.  Hence, liquidity position will influence the dividend pay-out of a particular year.

Expectations of the shareholders

Where there are large or significant institutional investors like mutual funds etc, the expectations of these shareholders need to be kept in view. Moreover, general expectations of the other shareholders should also be considered.  If higher pay-out is anticipated by them, a company should seriously consider this aspect. 

Rate of Dividend

If dividend is at a high rate, it may indicate that the company does not have good growth plans in near future.  A significantly high rate may also make the intelligent investors suspicious.  On the other hand, if the company declares too low dividend, it may indicate a liquidity crunch and perhaps a strained cash flow situation.  This may also make the investors apprehensive.  Particularly, also, where the Industry, in which the company operates, is doing financially very well and competing companies pay higher rate of dividend.

Dividend signaling.

It has been observed that increase in the dividend is often accompanied by an increase in the price of shares, and vice versa.  A divided reduction or non-payment of dividend in a year is likely to be bad news in the Stock Market. For this reason the dividend is an important signal which a company sends to the market

Cost of external financing

This has an impact on the dividend payout of a company.  Where the external funds are costlier the company may resort to low dividend payout and use the internal funds for financing its business needs.

General State of Economy

When the state of economy is uncertain, a company may maintain a low dividend payout guidelines to withstand business risks.

Promoters Stake

A higher Promoters’ stake in the share capital of a company may determine the dividend payout as proportionate quantum of dividend shall be paid to the Promoters themselves.

Dividend Cover

This indicates the number of times the dividends are covered by net profits.  This highlights the amount retained by the company for financing of future operations.

Dividend cover =  Profit after tax / Dividend

Dividend payout ratio.

This indicates the extent of net profits distributed as dividend.  High payout   signifies a liberal distribution policy.  A low payout reflects conservative distribution policy.

Dividend payout ratio  =  Dividend per share / Earning per share.

{III} Conclusion

Dividend is a very important pay out factor for companies, more particularly those widely held companies whose shares are listed on stock exchanges, sending signals to the market about their business health and the attitude of the management towards their stakeholders, however, a logical approach by companies may not be very widely prevalent. It is very important that Dividend Strategies should be given high priority by corporate.      

AMITAV GANGULY