Stable dividend policy and the methods of maintaining stability

Meaning. A stable dividend policy is one under which the company pays a regular, steady dividend that does not swing with every change in the year's earnings. Dividends are changed only when a change in earnings looks lasting. Many companies believe that such a policy maximises the market value of their shares, improves their image and makes it easier to raise funds for expansion.

Methods of maintaining stability

1. Constant dividend per share. A fixed amount is paid every year irrespective of actual earnings, and raised only when higher earnings look sustainable. To keep it up in poor years the company creates a Dividend Equalisation Reserve, invested in marketable securities, out of surplus earnings of good years. It suits persons and institutions that depend on dividend income.
2. Constant payout ratio. A fixed percentage of each year's net earnings is paid (for example, "up to 30% of profit after tax"). The dividend moves with earnings, so the payout is stable but the amount is not.
3. Small constant dividend plus extra dividend. A low regular dividend is paid every year, which the firm can maintain even in bad years, with an extra dividend in good years. The extra is labelled as such, so shareholders do not treat it as permanent; it gives flexibility while keeping the regular dividend steady.
4. Dividend based on long-term earnings. The dividend is fixed on a forecast of sustainable long-term earnings and raised gradually, only when earnings have risen to a substantially higher level.

Other aids to stability: paying interim dividends at regular intervals, issuing bonus shares in place of a cash increase when cash is short, and keeping enough liquid resources.