Stability or regularity of dividends is considered as, a desirable policy by the management of most companies. Shareholders, also generally favour this policy and value stable dividends higher than the fluctuating ones. All other things beings the same, stable dividend may have a positive impact on the market price of the share.
Stability of dividends sometimes means regularity in paying some dividend annually, even though the amount of dividend may fluctuate from yew and may not be related with earnings: There are a number of companies which have records of paying dividend for a long unbroken period. More precisely, stability of dividends refers to the amounts paid out regularly.
Three distinct forms of such stability may be distinguished:
- Constant dividend per share or dividend rate
- These are some of the examples of the restrictions put by
- Constant payout
Constant Dividend Per Share or Dividend Rate
A Number of companies follow the policy of paying a fixed amount per share or fixed rate on paid-up capital as dividend every year. Irrespective of the fluctuations in the earnings, this policy does not imply that the dividend per share or dividend rate will never be increased. When the company reaches new levels of earning s and expects to maintain it, the annual dividend per share may be increased.
It is easy to follow this policy when earnings are stable. If the earnings pattern of a company shows wide fluctuations, it is difficult to maintain such a policy. With earnings fluctuating from year to year, it is essential for a company, which wants to follow this policy to build up surpluses in years of higher than average earnings to maintain dividends in years of below average earnings. In practice, when a company retains earnings in good years for this purpose, it earmarks this surplus as reserve for dividend equalization. These funds are invested in current assets like marketable securities, so that they may easily be convened into cash at the time of paying dividends in bad years.
The dividend policy of paying a constant amount of dividend per year treats ordinary shareholders somewhat like preference shareholders without taking into account the firm’s or share-holders’ investment opportunities. Those investors who have dividends as the only source of their income prefer the constant dividend policy. They are hardly concerned about the changes in share prices. In the long run, such behavior helps to stabilize the market price of the share.
