If a company has a stable dividend policy then it tries to make a consistent payout each year regardless of how the business has performed. Instead of basing the dividend on the company’s performance over the short term, stable dividend policies are more closely linked with long-term prospects and forecasts. Ultimately, the policy aims to grow dividends at roughly the same rate as long-term earnings. A common way for a stable policy to be structured is to use a target payout ratio, which outlines what share of its earnings will be returned to shareholders over the medium to long term.
The benefit of a stable dividend policy is that payouts are reliable and consistent, even if the business suffers short-term turmoil. A company will try to honour the dividend even if it has had a bad year, dipping into cash reserves if profits are not enough to cover it, providing something of a safety net for shareholders. However, it may change the policy or rebase the dividend if it believes its sub-par performance will continue for longer. This also means that shareholders won’t see a large rise in distributions when the company has a better than expected year either, with companies more likely to retain the cash. A stable dividend policy comes with commitment. Investors expect dividends to remain consistent even if the business enters a downturn, although companies can hoard cash when things when are on the up as they are not obligated to return it to investors.