Understanding & Calculating Residual Dividend Policy: A Comprehensive Guide

Companies often establish a formal dividend policy indicating the proportion of earnings to be paid out to shareholders.

A dividend represents the share of earnings that a company distributes to its shareholders. Dividends may be paid in the form of cash or stock and are residual in nature because they represent the earnings distributed to shareholders after all of a company's obligations have been met and the management has allocated funds for reinvestment into the business.

Step 1

Procure the company's financial statements. The first step in calculating a company's residual dividend policy is to gain access to its financial statements. All publicly listed companies must register annual and quarterly reports with the Securities and Exchange Commission. These reports are available free of charge on the EDGAR Database of Online Corporate Financial Information. If the company is private, contact the company to request its financial records.

Step 2

Take note of the company's net income and dividends paid to shareholders. Turn to the company's income statement and locate the net income, or net earnings. This figure reflects the company's profit after all expenses have been accounted for, including interest and taxes. If the company pays a dividend, it normally appears below the net income line as dividends paid to shareholders.

Step 3

Calculate the company's retention ratio. The retention ratio, or plowback ratio, describes the proportion of earnings that are retained relative to earnings that are paid out in the form of a dividend. For example, a company that generated $1,000 of net income and paid a $200 dividend in one year has a retention ratio of 80 percent. This statistic is a measure of the company's residual dividend policy.

Step 4

Repeat the same process for as many historical periods as desired. A company may choose to have a stable dividend, one that grows or one that's determined arbitrarily. To understand the company's residual dividend policy, calculate the retention ratio for more than one historical period and take note of any variations.

Tip

High retention ratios are generally observed in high-growth companies that have a number of positive net present value investment opportunities, whereas low retention ratios are characteristic of mature companies.