How to Pay Dividends
by Bradley James Bryant
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.
Review the two main types of dividend payment methods. They are residual and stable. Most companies choose to use some combination of the two.
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.
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.
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.
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.