Dividend Policy Ratios

Dividend policy ratios provide insight into the dividend policy of the firm and the prospects for future growth. Dividend policy ratios measure how much a company pays out in dividends relative to its earnings and market value of its shares. They compare the dividends to the earnings to measure how much of its earnings a company is paying out in dividends. They also compare the dividends to share prices to see how much cash flow the investors get for their investments in the company’s shares.

Dividend payout ratio and dividend yield are two most common examples of dividend policy ratios. Dividend payout ratio gives an idea how well the earnings support the dividends paid out. Dividend yield measures how much a company pays out in dividends relative to the market value of its shares.

Generally speaking, the investors usually look for high dividend policy ratios therefore the companies should manage their dividend policies carefully. Companies need to manage their dividend policy ratios carefully to maximize the shareholder value. Market value of shares is greatly affected by the dividend policy ratios. Poor dividend policy ratios can result in fall of market value of shares and thus loss of shareholder value. On the other hand good dividend policy ratios can increase the prices of shares and shareholder value.

Dividend policy ratios are affected by the age of a company. Companies which are mature, stable and large in size usually pay higher dividends. Therefore dividend policy ratios of such companies are usually high. On the other hand, companies which are young, small and seeking growth usually do not pay any dividends or pay very modest dividends. Therefore dividend policy ratios of such companies are not so handsome.

It should be noted that high dividend policy ratios may not always be a good thing to seek. The earnings which are not paid out in dividends are reinvested for future growth of the company and its earnings. High dividend policy ratios may mean that the company does not have sufficient funds to invest in new projects for expansion and growth. The dividend policy ratio should try to achieve balance between short term cash flows to shareholders and future growth of the company and its earnings.

Dividend Yield

Dividend yield is the amount that a company pays to its shareholders annually for their investments. It is expressed as a percentage and indicates attractiveness of investing in a company’s stocks. Dividend yield is considered as ROI for income investors who are not interested in capital gains or long-term earnings. It is calculated as “Annual Dividend Per Share” divided by “Current Market Value Per Share”.

An example will help understanding Dividend Yield. If a company pays $2 as annual dividend and its shares are currently trading at $70/share. The dividend yield would be 2.9% ($2/$70 * 100).

Dividend yield indicates how much you are earning for each dollar invested in a company. Investors widely use this ratio in trend analysis and consider their past dividend yield ratios to decide whether to invest in the company or not. Dividend yield is most important for the investors who are seeking long term investments and a consistent return every year. Old companies have been observed consistent in paying dividends with a very small or no variation. Investment in such companies’ shares is relatively secure and less risky and their payout ratio is also high as compare to new companies. It also helps in making a comparison of other investments, such as, deposits, debentures, certificates, Govt. securities etc.

The dividend yield is defined as follows:

dividend-yield-onestopbrokers

Payout Ratio

Dividend payout ratio compares the dividends paid by a company to its earnings. The relationship between dividends and earnings is important. The part of earnings that is not paid out in dividends is used for reinvestment and growth in future earnings. Investors who are interested in short term earnings prefer to invest in companies with high dividend payout ratio. On the other hand, investors who prefer to have capital growth like to invest in companies with lower dividend payout ratio.

Dividend payout ratio differs from company to company. Mature, stable and large companies usually have higher dividend payout ratio. Companies which are young and seeking growth have lower or modest dividend payout ratio.

Investors usually seek a consistent and/or improving dividends payout ratio. The dividend payout ratio should not be too high. The earnings should support the payment of dividends. If the company pays high levels of dividends it may become for it to maintain such levels of dividends if the earnings fall in the future. Dividends are paid in cash; therefore, high dividend payout ratio can have implications for the cash management and liquidity of the company

The payout ratio is defined as follows:

payout-ratio-onestopbrokers

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