Companies must worry about their dividend policy when interest rates are rising. As the economy and stock markets become more volatile, companies worry about maximizing their capital by staying on the cutting edge of debt management. Dividend policy is a company’s strategy for dividends in a rising interest rate environment. Here are some ways in which dividend policy is determined.
1. By the Policies of the Board of Directors
When a company goes public, stockholders buy shares with their hard-earned money and commit to this company. When shareholders hold shares, they expect a return on their investment. Therefore, it becomes important for the directors to have a set policy regarding dividend payments.
To prevent companies from cutting or suspending dividends because they are scared of losing money, stockholders can elect new members of the Board. The latter have different views and visions on dividend policies. Some directors prefer dividends as part of their long-term plans; others see it as an advantage to having enough profit to make future investments in research and development.
2. Corporate Policies
This is the most common procedure for determining dividend policy. Companies usually follow a general business policy to dictate dividends, such as “to maintain a consistent level of dividend payments to its shareholders.” When boards set their policies, they are usually aligned with the company’s overall financial status and with the objective of maximizing profits.
According to a recent study, stocks with the most consistent dividends have higher growth percentages in their stock price than those that don’t pay dividends out of mathematically based considerations.
3. Dividend Approval Structure
When a company has shareholders who share an understanding of its business and financial position, it is easier for them to discuss dividend policy in light of their specific interests. Unlike business policies, investment managers are more likely to be influenced by how much current stockholders want the company to pay out profits for projects that will positively affect future earnings and the share price.
4. Dividend Payout Ratio
As a company’s profitability increases, the dividend payout ratio becomes useful in gauging its financial management. A company that cannot expand its business and maintains costs effectively may need to adjust its dividend payout schedule.
Stockholders of companies with low payout ratios are attracted to stocks with high growth potential, while those seeking dividends choose stocks with higher payout ratios. When a company has a good financial condition, paying dividends becomes an option for them. The business will be able to pay dividends as long as earnings can meet obligations, especially if the ratio is above 50 percent.
5. Dividend Forecasts
The dividend forecast is used to estimate future dividend payments. The forecast will result in a more accurate prediction of the level of dividends when compared with other types of methods. Many companies are now considering dividend forecasts to assess their performance instead of only looking at actual reported figures and ratios.
Moreover, different forecast models have been developed that can be adjusted depending on their situations. For example, a model will be helpful to corporations if they happen to have high dividend payouts, while another model is appropriate for companies with a low payout ratio.
6. Dividend Growth and Dividend Decline Ratios
A company’s growth in total dividends is a valuable indicator of its strength. A company with higher growth in both dividends and earnings can help you identify companies that may not be at their best performance but will still give you a winning investment, as long as your investment thesis remains valid.
Companies that pay out more dividends than they need to are among the most attractive stocks. These stocks are usually those that are not yet fully recovered from the recessions of the past decade but have gained market share by raising prices rapidly beyond their old price levels. Such companies may still have much money to invest in their operating activities, research and development projects, or acquisitions.
7. The Current Market Environment and Macroeconomic Factors
The Federal Reserve’s policies, or perhaps the bond market, might influence how much the company pays out in dividends. The bond market is an opportunity for companies to raise funds cheaply.
On the other hand, investors are likely to invest in bonds with a higher interest rate if they are more concerned with income security than with a company’s performance. In addition, the company’s future earnings growth depends on many factors, including the economic environment and future monetary policy.
The dividend policy is one of the best indicators for future returns because it helps to ensure that you are investing in a financially sound company, growing in dividends and cash flows, with a competitive advantage, and capable of paying dividends. Dividend policy is not easy to change once established. However, dividend policy is subject to change as board members need to maintain their business interests.