Dividend policy

A company's dividend policy is the company's usual practice when deciding how big a dividend payment to make.

Dividend policy may be explicitly stated, or investors may infer it from the dividend payments a company has made in the past. If a company states a dividend policy it usually takes the form of a target pay-out ratio.

If a company has not stated a dividend policy then investors will infer it. Assumptions that investors are likely to make are:

  • The DPS will be maintained at at least the previous year's level (excluding special dividends) — unless dividend cover is very low or the company has warned that a dividend cut is possible
  • If the payout ratio has been maintained at a roughly constant level in the past, the same will be done in the future
  • Any other pattern of dividend growth will continue as long as the cover does not fall too low.

Companies do not normally increase dividends unless they are confident that the increase is sustainable. This means that increasing the dividend is a way in which the management of a company can signal investors that they are confident.

Conversely, dividend cuts are often an acknowledgement of some permanent deterioration in a company's business. Sometimes it only reflects a need to keep cash for capex. It is usually clear which it is.

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