Dividends are a portion of a company’s earnings paid to eligible share owners per share basis. So, if you own a share in a company that has declared a dividend, you’ll receive a dividend payment for each share. You can generate investment income by investing in individual shares that pay dividends and dividend-paying funds, like many mutual funds or ETFs. While dividends can play a role in a diversified, fixed-income portfolio, dividend declaration is not guaranteed, and even if declared, the amount may fluctuate year on year.
A dividend policy lays out what percentage of a company’s earnings would be paid to its shareholders. For example, a company may have the policy to pay 50% of its earnings out as dividends each year. So if the company earned INR 1 Cr in a given year, it would pay INR 50 Lakhs in dividends. There are three significant types of dividend policies.
Three Major Types of Dividend Policies
- Residual Dividend Policy
- Stable Dividend Policy
- Hybrid Dividend Policy
All the dividend policies mentioned above have their advantages and disadvantages. A residual approach allows the company to maintain a specific preferred capital structure (i.e., debt/equity). In contrast, a stable dividend policy, as the name implies, tends to declare consistent yearly dividends. A hybrid approach mixes the priorities of the residual and stability policies, allowing a company to have a more flexible debt/equity ratio to set a more stable dividend payout rate.