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Dividends > Introduction to Dividends
Introduction to Dividends
• Defining Dividends
• The Nature of Dividends
• Dividend Irrelevance Theory
• Value of a Low Dividend
• Value of a High Dividend
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Dividends > Introduction to Dividends
Defining Dividends
• Dividends are periodical payments a corporation can choose to issue to its
shareholders, with the amount of payment to each shareholder commensurate
with their number of shares. They may be paid as cash, additional stock, or
property.
• Dividends may also be categorized as common stock or preferred dividends;
preferred stock owners get their dividends paid in full first, before any common
stock dividends are distributed.
• Ratios using dividend value, such as dividends per share (DPS), dividend yield,
and payout ratio have historically been used as indicators of a stock's investment
strength and the company's overall performance, though their usefulness has
been contested.
Historical dividend information for Franklin
Automobile Company
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Dividends > Introduction to Dividends
The Nature of Dividends
• Dividends offer consistent returns on relatively low risk investments. While
companies experiencing rapid growth are unlikely to offer dividends, established
companies with stable business and less room to grow do pay dividends to
shareholders.
• A firm's dividend decision may also serve as a signalling device about a firm's
future prospects. Due to information asymmetry between investors and the firm
managers, investors will look to indicators like dividend decisions, which may give
clues about what the firm managers forecast for the firm.
• Critics of dividends contend that company profits are better used reinvested back
into the company for research, development, and capital expansion.
Stock prices shown in a ticker in Tokyo, Japan
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Dividends > Introduction to Dividends
Dividend Irrelevance Theory
• Dividend irrelevance comes from Modigliani-Miller's capital irrelevance model,
which works under specific market conditions–no taxes, no transaction costs, and
no flotation costs. Investors and firms must have identical borrowing and lending
rates and the same information on the firm's prospects.
• Firms that pay more dividends offer less stock price appreciation. However, the
total return from both dividends and capital gains to stockholders should be the
same, so stockholders would ultimately be indifferent between the two choices.
• If dividends are too small, a stockholder can simply choose to sell some portion of
their stock for cash and vice versa.
Merton Miller
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Dividends > Introduction to Dividends
Value of a Low Dividend
• A relatively low payout could mean that the company is retaining more earnings
toward developing the firm instead of paying stockholders, which hints at future
growth. Future capital gains also have tax advantages. These are all factors in
favor of investing in stocks with low dividends.
• If a stock has a low dividend yield, this implies that the stock's market price is
considerably higher than the dividend payments a shareholder gets from owning
the stock. This may indicate an overvalued stock or larger dividends in the future.
• A history of low or falling yields may indicate that the firm's cash situation is not
stable. They cannot afford to give higher dividends because they do lack cash on
hand. As a result, there is some measure of risk involved with these low dividend
Investor preferences for low dividend payouts
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investments.
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Dividends > Introduction to Dividends
Value of a High Dividend
• A high-yield stock is generally considered as a stock whose dividend yield is
higher than the yield of any benchmark average such as the 10 year U.S.
Treasury note, although the exact classification of high yield may differ depending
on the analyst.
• High-yield may indicate undervaluation of the stock because the dividend is high
relative to stock price or it can be a sign of a risky investment. If the high yield is
due to a declining stock price, that reflects poorly on the firm's performance and
suggests that the dividend is unsustainable.
• Generally speaking, firms that usually pay out high dividends are quite mature,
profitable, and stable. They pay out high dividends simply because they have too
High dividend gambles
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much cash flow and few positive net present value investment possibilities.
• The Dogs of the Dow strategy is a famous and extreme strategy using high
dividend yields, where the investor buys the 10 highest dividend yielding stocks
from the Dow Jones Industrial Average.
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Appendix
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Dividends
Key terms
• capital gains Profit that results from a disposition of a capital asset, such as stock, bond, or real estate due to arbitrage.
• dividend A pro rata payment of money by a company to its shareholders, usually made periodically (e.g., quarterly or annually).
• dividend cover The ratio of total earnings to total dividend payments.
• dividend irrelevance Theory that a firm's dividend policy is not relevant because stockholders are ultimately indifferent between
receiving returns from dividends or capital gain.
• dividend yield A company's total annual dividend payment per share, divided by its price per share.
• dividend yield A company's total annual dividend payment per share, divided by its price per share.
• dividends per share The amount shareholders earn per share.
• Dogs of the Dow An extreme investing strategy that dictates buying the 10 stocks with the highest dividend yields from the Dow
Jones Industrial Average at the beginning of the year.
• flotation costs Costs paid by a firm for the issuance of new stocks or bonds.
• information asymmetry In economics and contract theory, information asymmetry deals with the study of decisions in
transactions where one party has more or better information than the other.
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Dividends
High dividend gambles
Risk aversion can be applied to many different situations including investments, lotteries, and any other situations with uncertain outcomes.
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Dividends
Historical dividend information for Franklin Automobile Company
Dividends are one of the privileges of stock ownership, and preferred shares get more rights to them than common shares do.
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Dividends
Stock prices shown in a ticker in Tokyo, Japan
Stock prices may be informed by a firm's dividend decisions.
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Dividends
Investor preferences for low dividend payouts
According to the clientele effect, firms offering low dividend payout will attract certain investors who are looking for a long term investment and would like
to avoid taxes.
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Dividends
Merton Miller
Merton Miller, one of the co-authors of the capital irrelevance theory which implied dividend irrelevance.
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Dividends
Which of the following is an accurate description of one of the
dates related to issuing dividends.
A) The ex-dividend date refers to when the shareholders must be
registered on record.
B) The declaration date is the day the board of directors announces it will
pay a dividend.
C) The in-dividend date is the last day when the stock is cum dividend.
D) All of these answers.
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Dividends
Which of the following is an accurate description of one of the
dates related to issuing dividends.
A) The ex-dividend date refers to when the shareholders must be
registered on record.
B) The declaration date is the day the board of directors announces it will
pay a dividend.
C) The in-dividend date is the last day when the stock is cum dividend.
D) All of these answers.
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Dividends
Which of the following statements regarding what dividends can
mean to prospective investors is true?
A) Dividends provide consistent returns on relatively low risk investments.
B) A signal that earnings generated by the stock will be volatile.
C) All of these answers.
D) Dividends do not help mitigate information asymmetry between
investors and firm manag
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Dividends
Which of the following statements regarding what dividends can
mean to prospective investors is true?
A) Dividends provide consistent returns on relatively low risk investments.
B) A signal that earnings generated by the stock will be volatile.
C) All of these answers.
D) Dividends do not help mitigate information asymmetry between
investors and firm manag
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Dividends
The Modigliani-Miller theory suggests that it doesn't matter to a
shareholder whether a company issues dividends. Why might that
theory not be applicable to the US stock market as it currently
exists?
A) There is information asymmetry between the company's managers
and its investors.
B) Financial leverage does affect a company's cost of capital.
C) There are transaction costs associated with trading stock.
D) All of these answers.
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Dividends
The Modigliani-Miller theory suggests that it doesn't matter to a
shareholder whether a company issues dividends. Why might that
theory not be applicable to the US stock market as it currently
exists?
A) There is information asymmetry between the company's managers
and its investors.
B) Financial leverage does affect a company's cost of capital.
C) There are transaction costs associated with trading stock.
D) All of these answers.
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Dividends
Under the Modigliani-Miller theorem in finance, the value of a
company depends on:
A) stock returns and dividends.
B) the competitive situation of the company and the projects that the
company undertakes and plans.
C) the capital structure of the company.
D) how managers work together.
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Dividends
Under the Modigliani-Miller theorem in finance, the value of a
company depends on:
A) stock returns and dividends.
B) the competitive situation of the company and the projects that the
company undertakes and plans.
C) the capital structure of the company.
D) how managers work together.
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Saylor OER. "Business Administration « Saylor.org – Free Online Courses Built by Professors."
CC BY 3.0 http://www.saylor.org/majors/Business/
Dividends
Which of the following is a benefit of a company paying a smaller
dividend?
A) It could lead to lower taxes in the long-run for the shareholder.
B) All of these answers.
C) More money is being reinvested by the company in new products,
.increasing its overall value
D) A low dividend yield may indicate that the firm is experience rapid
growth.
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Dividends
Which of the following is a benefit of a company paying a smaller
dividend?
A) It could lead to lower taxes in the long-run for the shareholder.
B) All of these answers.
C) More money is being reinvested by the company in new products,
.increasing its overall value
D) A low dividend yield may indicate that the firm is experience rapid
growth.
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Dividends
Which of the following statements is true about companies that
pay a high dividend?
A) Generally speaking, most firms that pay high dividends are mature,
profitable, and stable.
B) When a dividend paying stock's price falls, it may reflect investor fears
of a dividend cut.
C) All of these answers.
D) High-yield stock tend to outperform low and no yield stocks during
bear markets.
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Dividends
Which of the following statements is true about companies that
pay a high dividend?
A) Generally speaking, most firms that pay high dividends are mature,
profitable, and stable.
B) When a dividend paying stock's price falls, it may reflect investor fears
of a dividend cut.
C) All of these answers.
D) High-yield stock tend to outperform low and no yield stocks during
bear markets.
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Dividends
Attribution
• Wikipedia. "Value vs Growth Investing." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Value_vs_Growth_Investing
• Wikipedia. "Dividend cover." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend_cover
• Wikipedia. "Dividend yield." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend_yield
• Wikipedia. "dividend yield." CC BY-SA 3.0 http://en.wikipedia.org/wiki/dividend%20yield
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/dividend-cover
• Wikipedia. "The Dividend Decision." CC BY-SA 3.0 http://en.wikipedia.org/wiki/The_Dividend_Decision
• Wikipedia. "Dividend." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend#Reliability_of_dividends
• Wikipedia. "Corporate finance." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Corporate_finance#The_dividend_decision
• Wikipedia. "information asymmetry." CC BY-SA 3.0 http://en.wikipedia.org/wiki/information%20asymmetry
• Wikipedia. "High-yield stocks." CC BY-SA 3.0 http://en.wikipedia.org/wiki/High-yield_stocks
• Wikipedia. "Blue chip (stock market)." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Blue_chip_(stock_market)
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/dogs-of-the-dow
• Wikipedia. "Dividends." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividends
• Wikipedia. "dividend yield." CC BY-SA 3.0 http://en.wikipedia.org/wiki/dividend%20yield
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/dividends-per-share
• Wiktionary. "dividend." CC BY-SA 3.0 http://en.wiktionary.org/wiki/dividend
• Strona Glowna. "Dividend irrelevance theory - Encyclopedia of Management." GNU FDL
http://mfiles.pl/en/index.php/Dividend_irrelevance_theory
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Dividends
• Wikipedia. "Modigliani-Miller theorem." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Modigliani-Miller_theorem
• Wikipedia. "Dividend policy." CC BY-SA 3.0 http://en.wikipedia.org/wiki/Dividend_policy#Irrelevance_of_dividend_policy
• Wikipedia. "capital gains." CC BY-SA 3.0 http://en.wikipedia.org/wiki/capital%20gains
• Wikipedia. "dividend irrelevance." CC BY-SA 3.0 http://en.wikipedia.org/wiki/dividend%20irrelevance
• Boundless Learning. "Boundless." CC BY-SA 3.0 http://www.boundless.com//finance/definition/flotation-costs
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