How to Pay Dividends

by Bradley James Bryant

Overview

There are two ways for investors to take an ownership in a company: dividends and share price appreciation. Dividends are usually quarterly payments paid to each share of stock. For instance, a company can declare .25 dividends per quarter for a total of $1 total dividend per share for the entire year. There are two commonly used dividend policies used: residual and stable.

Step 1

Review the two main types of dividend payment methods. They are residual and stable. Most companies choose to use some combination of the two.
Step 2

Determine which type of method to use. A residual dividend policy pays out of internally generated funds which are leftover after new projects are financed.
Step 3

Review a residual dividend example. Let's say that XYZ Company has recently earned $100 and wants to maintain a debt to equity ratio of 50 percent (1:2). If the company has new projects that cost $90 it would pay 1/3 using debt ($30) and two thirds using equity ($60) to maintain debt to equity ratio. Since the company is borrowing $30, this leaves a residual of $40 ($100 - $60) for dividends.
Step 4

Review the stable dividend policy. This policy concentrates on setting the dividend at a fixed fraction of quarterly earnings. The aim of the stability policy is to reduce uncertainty.
Step 5

Walk through an example of stable dividend policy. Going back to our company, let's say the company decided on a stable policy of 10 percent of yearly earnings. This would pay $2.5 (($100x10 percent)/4) to shareholders every quarter.