Earnings Stability Homework Help

Earnings Stability

The stability of earnings also has a significant bearing on the dividend decision of a firm. Generally, the more stable the income stream, the higher is the dividend payout ratio. Such firms are more confident of maintaining a higher payout ratio. Public utility companies are classic examples of firms that have relatively stable earnings pattern and high dividend payout ratio. Growing firms, characterised by stable earnings, can muster debt funds at a relatively lower cost because of a smaller total risk (business and financial). This is unlike the experience of other firms which, though growing, suffer from fluctuating earnings.

However, the financial manager should remember that dividends have information value. With holding.the payment of dividends will raise the required rate of return of the investors and, therefore, depress the market price of the shares. The increase in earnings should be such that it can offset the unfavourable effect of the increased cost of equity (ke).

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