Examination of 3 forms of a

Stable Dividend Policy

These examination requires addressing the following
questions:
2. What is their relative suitability ?
3. What are their implication to the shareholders & the
firm ?
4. Which form would find favour with the investors ?

 Constant Payout Ratio guards against

overpayment as well as underpayment of dividends
because management can not pay dividends if there
are no profits & it can not withhold them when
profits are earned.
From the shareholder’s view point, this method
involves uncertainty & irregularity in regard to the
expected dividends.

 Stable Rupee Dividend Plus Extra Dividend is

suitable for companies whose earnings fluctuate
widely. From the investor’s view point, the extra
dividend is of sporadic nature.
 Constant Dividend Per Share gives an assured fixed amount
as dividends which has gradually & consistently increase over
the years.

Why should a firm follow stable dividend

policy ?
Various reasons are as follow:-:-
6. Desire for current income
7. Informational Contents
8. Requirements of Institutional Investors

# A company should seek stable dividend policy which avoids

occasional reduction of dividends. Investors favourably react to
the price of shares of such companies & there is a price
enhancing effect of such policy as it resolves the uncertainty
from the minds of the investors regarding the anticipated
stream of dividends.
 EXAMPLE
X & Y ARE TWO FAST GROWING COMPANIES IN THE ENGINEERING INDUSTRY.
THEY ARE CLOSE COMPITITORS & THEIR ASSETS COMPOSITION, CAPITAL
STRUCTURE & PROFITABILITY RECORDS HAVE BEEN VERY SIMILAR FOR SEVERAL
YEARS. THE PRIMARY DIFFERENCE BETWEEN THEM FROM FINANCIAL
MANAGEMENT PERSPECTIVE IS THEIR DIVIDEND POLICY. THE COMPANY X TRIES
TO MAINTAIN A NON DECREASING DIVIDEND PER SHARE, WHILE THE COMPANY Y
MAINTAINS A CONSTANT DIVIDEND PAY OUT RATIO. THEIR RECENT EARNING PER
SHARE(EPS), DIVIDEND PER SHARE (DPS), & SHARE PRICE (P) HISTORY ARE AS
FOLLOWS:::::

Year COMPANY X COMPANY Y

EPS DPS P(RANGE) EPS DPS P(RANGE
)
1 Rs 9.30 Rs 2 Rs 75-90 Rs 9.50 Rs Rs 60-80
2 7.40 2 55-80 7.00 1.90
1.40 25-65
3 10.50 2 70-110 10.50 2.10 35-80
4 12.75 2.25 85-135 12.25 2.45 80-120
5 20.00 2.50 135-200 20.25 4.05 110-225
6 16.00 2.50 150-190 17.00 3.40 140-180
7 19.00 2.50 155-210 20.00 4.00 130-190
 QUESTIONS OF EXAMPLE

IN ALL CALCULATIONS BELOW THAT REQUIRE A SHARE PRICE, USE THE

AVERAGE OF THE TWO PRICES GIVEN IN THE SHARE PRICE RANGE.

(A) DETERMINE THE DIVIDEND PAYOUT RATIO (D/P) & PRICE TO

EARNINGS(P/E) RATIO FOR BOTH COMPANIES FOR ALL THE
YEARS.

(B) DETERMINE THE AVERAGE D/P & P/E FOR BOTH THE COMPANIES OVER
THE PERIOD 1 THROUGH 7.

(C) THE MANAGEMENT OF COMPANY Y IS PUZZLED AS TO WHY THEIR

SHARE PRICES ARE LOWER THAN THOSE OF COMPANY X, IN
SPITE OF THE BETTER PROFITABILITY RECORD PARTICULARLY
OF THE PAST 3 YEARS.

AS A FINANCIAL CONSULTANT, HOW WOULD YOU EXPLAIN THE

SITUATION ?????????
 SOLUTION
D
(A) & (B) D/P & P/E RATIOS
YE COMPANY X COMPANY Y
AR EPS DPS D/P P P/E EPS DPS D/P P P/E
RATI RATIO RATI RATIO
1 9.30 2.00 O
21.5 82.50 8.87 9.50 1.90 O
20 70 7.37

2 7.40 2.00 27.5 67.50 9.12 7.00 1.40 20 45 6.43

3 10.50 2.00 19.0 90.00 8.57 10.5 2.10 20 57.50 5.48

0
4 12.75 2.25 17.6 110.0 8.63 12.2 2.45 20 100.0 8.16
0 5 0
5 20.00 2.50 12.5 167.5 8.37 20.2 4.05 20 167.5 8.27
0 5 0
6 16.00 2.50 15.6 170.0 10.62 17.0 3.40 20 160.0 9.41
0 0 0
7 19.00 2.50 13.2 182.5 9.6 20.0 4.00 20 160.0 8.00
0 0 0
94.95 15.7 16.6 870.0 9.16 96.5 19.30 20 760.0 7.88
5 0 0 0
(c) COMPANY X IS FOLLOWING A STABLE DIVIDEND POLICY WHEREAS
COMPANY Y IS FOLLOWING A STABLE DIVIDEND PAYOUT RATIO.

IN THE LATTER TYPE OF POLICY, SPORADIC DIVIDEND PAYMENTS

OCCUR WHICH MAKE ITS OWNERS VERY UNCERTAIN ABOUT THE
RETURNS THEY CAN EXPECT FROM THEIR INVESTMENT IN THE FIRM
&, THEREFORE, GENERALLY DEPRESS THE SHARE PRICES.

IT IS PROBABLY FOR THIS REASON THAT THE COMPANY X’S

AVERAGE PRICE PER SHARE EXHIBITED A CONSISTENT INCREASE
COMPARED TO COMPANY Y, VOLATILE PATTERN OF EARNINGS OF
BOTH COMPANIES (DURING THE LAST 3 YEARS) NOTWITHSTANDING.

SO COMPANY Y IS ADVISED TO FOLLOW A STABLE DIVIDEND POLICY.