Dividend policy

An important element to consider when investing on the stock market is the dividend policy. It seems that the recurring revenues coming from them are either loved or hated by investors. People enjoy dividends because of the nice stable cash inflows provided. Others believe that firms are destroying value by choosing to distribute cash instead of selecting other projects (research, acquisitions, etc.). Opinions vary but one thing is for sure: you need to be aware of key factors influencing companies' dividend policy.

Information: It is assumed that insiders know more about their companies than the general public. Dividends can be seen as a source of information or a signal of management's intentions. For example, a firm paying a dividend for the first time ever could be signalling to the market that it doesn't have interesting projects to invest its cash in.

Cash availability: Profitable companies don't always pay dividends. Some of them have tight cash reserves and can't afford to distribute cash to investors.

Control: It seems that firms controlled by a small group of shareholders use auto-financing more often than firms with many shareholders. A small number of shareholders means that firms don't need to "buy peace" or "spread more information" with dividends.

Taxes: In many countries, capital gains are taxed less than dividends. A clientele effect is in place since firms paying high dividends will attract investors with a low tax rate.

Costs of issuing shares: Since issuing shares is costly, some companies prefer not to pay dividends. Indeed, the cash distributions could mean that the need to issue more shares will come more often.

Net income stability: In response to the negative signal sent by a highly fluctuating net income, firms might want to signal some operations stability with stable dividends.

Whether you like or dislike dividends, it is important to analyze the 6 key factors because they can tell you a lot about firms' future dividend policy. It is another piece of the puzzle leading to successful stock market investing.