They will pay dividends only when the earnings for the period exceed the amount of equity required for financing investments.
Required Investment
Firs, estimate the dollar amount required for planned investments.
Common Equity Financing
Next, determine the amount of common equity to finance the investments,maintaining the optimal capital structure.
Pay Dividends
Finally,pay dividends from any residual earnings.
The residual dividend policy maximizes capital gains and postpones to be paid by shareholders.
Constant payout policy
Under this policy,dividends are paid as a constant perecentage of earnings.
Fluctuations in Dividends:The constant payout policy can cause fluctuations in dividends if earnings are volatile.
Policy usage:Very few companies use this policy since the payment of future dividends is uncertain
Stable dividends with growth
Avoiding swings in stock prices:It avoids swings in a company’s stock prices caused by variable dividends.
The policy is as follows:Dividend Payment:Conservatively low,stable dividends.
Payout Ratio:They payout ratio is allowed to fluctuate as earnings change.
Dividends rates over time:Dividend rates are increased only when the company maintains higher levels of earnings for several years.
Stable dividends with growth plus an extra dividend
In this policy,the board of directors follows the stable dividend with growth policy and adds an additional dividend at year-end when earnings are exceptionally high.
Dividend matching:This allows the matching of dividends to the amount of current earnings.
“Extra”dividend:The “extra”dividend signals to investors that this dividend may not reoccur in the future.