When companies earn profits from their operations, there are various options available to them on how to use those profits. They can choose to retain those profits in the company and use them for long term expansion projects, distribute them to the shareholders, or mix the first two options. How companies decide to deal with their profits with regard to their shareholders is what is referred to as dividend policy.
Understanding the dividend policy of a company you want to invest in is of much importance since it touches directly on the income you expect to get from your investment. Especially if you are interested in regular annual incomes, the dividend policy applied by your company of choice should be of prime concern to you. For long term investors interested in capital gains, the dividend policy is of importance too since dividends can be reinvested and thus increase your ultimate wealth in the long run.
It therefore goes without saying that you need to know the various dividend policies available and how to maximize your returns by taking advantage of them. The various dividend policy options available include:
- CONSTANT DIVIDEND AMOUNT
This policy implies that each year the shareholders of the company get a fixed amount of dividend regardless of the profits made by the company. This is best for people seeking a source of constant annual income that they can even budget for before it comes; especially the retired guys.
- CONSTANT DIVIDEND PAYOUT RATIO
This policy implies that shareholders get a given fixed percentage of dividend of each year`s profits. If the percentage is fixed at 10%, then each year the shareholders will be taking home 10% of the total net profits.
Here the dividend received varies from year to year, with high profits meaning more dividends and vice versa.
- CONSTANT DIVIDEND PLUS EXTRA
This policy implies that a fixed amount of dividend is distributed to the shareholders each year; however, during years when there is better performance, the shareholders benefit from an extra amount of dividend added to their normal annual amount.
- RESIDUAL DIVIDEND POLICY
This is a policy where shareholders get a dividend if the company has no profitable investment projects to undertake with the money as at the moment or in the foreseeable future. This then means that investment decisions are given a first priority over dividends, but dividends are paid out in years when there are no investment projects.
Dividends are also paid out from the extra money remaining after undertaking the investment project planned.
- NO DIVIDEND
This is a policy whereby the company decides not to pay any dividends to its shareholders for a given period of time. Mostly this is done when the company has long-term investment projects it wants to invest in or expansion plans it wants to undertake.
This then means that the shareholders of such companies rely solely on the capital gains of the shares to make a killing for the period when the dividends are not paid.
It is always a wise thing to do when you get to know the dividend policy of your company before you invest in it. It will help you plan your investment even better and do a better projection of your future returns.
Check out this dividend policies from the company`s financial statement and reports; mostly the financial reports can be downloaded from the company`s website.