Key Factors That Influence Dividend Policies

By Motley Fool

Did you ever wonder why some companies pay dividends while others don't? There are several factors that influence whether or not a company pays a dividend and how much it chooses to pay. While there are too many possible factors to list here, these are some of the most influential.

Is the company's income stable?Income stability is one of the top factors in determining dividend policies. Specifically, established companies with stable, predictable income streams are more likely to pay dividends than companies with growing or volatile income.

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Newer and rapidly growing companies rarely pay dividends, as they prefer to invest their profits back into the company to fuel even more future growth. And, companies with unstable revenue streams often choose not to pay dividends, or pay small dividends in order to make sure the payout will be sustainable.

It looks terrible to investors when companies are forced to suspend or reduce dividend payments, so most like to err on the side of caution when deciding to implement a new dividend, waiting for several years of stable profits before doing so.

Can profits be put to better use?Another factor that can influence management's dividend policies is the potential for better returns through capital reinvestment. In other words, if a company feels that it would be in the best interest of its shareholders to use its profits for other business activities besides paying dividends, it could choose not to pay even if its revenues are stable and predictable.

One great example of this is Warren Buffett's Berkshire Hathaway, which has never paid a dividend. Instead, Buffett feels that reinvesting the company's profits is a far better idea -- and he's been right. Berkshire has produced phenomenal returns for decades, and a big reason was the compounding effect of reinvesting its profits instead of paying them out.

Tax considerationsDividends are effectively taxed twice -- once at the corporate level, and again when they are paid out to shareholders.

Because of this, many companies (and their investors) feel that other methods of returning capital, such as share repurchases, are a better way to go. Repurchasing shares has the same net effect as a dividend payment -- the intrinsic value of the company's shares increases as the share count drops. However, this can allow investors who like to reinvest their dividends to do so without having to worry about dividend taxes.

Legal requirementsIt's also worth noting that some companies have no choice but to pay dividends. For example, real estate investment trusts (REIT) receive some pretty nice tax benefits, but they are legally required to pay at least 90% of their income to shareholders.

On the other hand, some companies need to obtain approval before paying/increasing their dividends. Since the financial crisis, many banks need to submit capital plans for regulatory approval for any plans to boost their payouts.

Economic conditionsFinally, another major factor that influences dividend policies is the market environment. If a certain sector is having trouble and anticipates profits falling, it's common for companies to get quite defensive when it comes to their dividends.

This can be seen currently in the energy sector, where low oil prices have wreaked havoc on many companies' profitability, which has led to several major companies slashing their dividends recently.

The Foolish bottom lineAs I mentioned earlier, this isn't an exhaustive list, and there can be many company-specific reasons for implementing, increasing, and cutting dividends, in addition to those mentioned here. For example, New York Community Bankpaid out uncharacteristically high dividends for a few years in order to remain under the $50 billion regulatory threshold.

The bottom line is that there are several key factors that make up each company's dividend policy, and they can change over time as companies evolve and mature, and as economic conditions change.

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