CFA Level II ExamCorporate IssuersMedium
A portfolio manager is analyzing a company's dividend policy. The company has a history of consistently increasing earnings and has adopted a policy of paying out a fixed percentage of its earnings as dividends. Which of the following best describes this dividend policy?
- AConstant dividend payout ratio policy
- BStable dividend policy
- CResidual dividend policy
- DConstant dividend per share policy
Show answer & explanationAnswer & explanation
Correct answer: A. Constant dividend payout ratio policy
A constant dividend payout ratio policy means the company pays out a fixed percentage of its earnings as dividends. This would result in variable dividends per share if earnings fluctuate, but the ratio remains constant.
Why the other options are wrong
- B. A stable dividend policy aims for a steadily increasing dividend per share, not necessarily a constant payout ratio.
- C. A residual dividend policy pays out only what's left after funding all acceptable investment projects.
- D. A constant dividend per share policy pays the same dollar amount per share, regardless of earnings fluctuations, which is different from a percentage of earnings.
Constant Dividend Payout Ratio Policy
A dividend policy where a company pays out a fixed percentage of its net income as dividends to shareholders.
- Dividends per share will fluctuate with earnings.
- Signals management's confidence in future earnings.
- Can lead to volatile dividends, which some investors dislike.
Memory trick: Ratio for percentage, stable for growth, residual for leftovers, constant for fixed cash.