Dividend Policy One of the Term Paper

Excerpt from Term Paper :

Even their regular dividends were increased from 8 cents per share per quarter to 16 cents. This is quite a high rate of increase. This sort of announcements was also made by banks like Wachovia and Mellon, and consumer staples like Altria and Kraft. The attitude of the investors can be seen from the fact that the companies which have traditionally paid dividends have performed better in terms of share price than shares which do not pay good dividends, and this change has started from the beginning of 2004. Part of the change in attitudes of the companies may have come because of the reduction in taxation, which has been discussed already. (Dividends Are Back!)

Even in Europe, companies like Carrefour have increased their dividends, and this has led to improvements in market values of their stock. We are all aware that ordinary stocks do not guarantee the payment of any dividend, and the payment of dividend depends on profitability and available cash. There are differences between different dividends as they have to be paid at different times, and also there are fluctuations of dividends in ratios. There are also situations when a company is unable to pay any dividend at all. At the same time, it is because of these factors, the dividends become a key determinant of the price of a share. The share price is determined by some experts on dividends rate, dividends' growth rate and discount rate. The discount rate is otherwise called the required income rate, and is dependent on the risk level in the business that the company is involved in. Since there are risks in the concerned business, the assets of the company also have to be discounted according to the calculated risks.

Discussing the matter of investors using dividends as guides for the valuation of securities, one can use the following indices. The first is the dividend yield and this can be described as the dividend per share paid by the company divided by the purchase price paid for the stock. This shows the yield rate for the investor in relation to the investment made by him. The second part is the dividend payout ratio, and this is the ratio that dividends form of the total earnings of the company. This is also looked at as the retention ratio which is one minus the dividend payout ratio. The third is the growth rate of dividends paid by the company. The three indices together give a total model for the security like the dividend discount and APT. When the dividend yield is low, it means that the share has been purchased at to high a price, or that the financial position of the company has declined after the shares were purchased. When the company has not taken the serious step to stop paying dividends even after this, it just means that the company management is not taking required disciplinary measures. (Dividends Are Back!)

If on the other side, there is growth, then it means that there has been a value strategy in the investment. The question also comes as to whether the company should pay out its earnings in dividends or retain them for growth of the company? This view leads to some experts suggesting that some companies retain capital for the target of achieving growth. This is also reflected in the fact that 'mature' companies that have already passed their performance peaks in growth rate are the ones that pay out a high rate of dividend. This is not always true as some studies have shown a direct relationship between high dividend payment in the present situation and a high rate of growth also now. The other points of long-term discount model are a technique for the use of financial experts for an attempt at the direct evaluation of the value within the company, and thus get a correct price for the securities concerned with the company. This is also a route to price capital assets, and that forms one of the basic points in the theory of corporate finance. All this leads to the belief that a high payment of dividend will continue in future and this will thus continue to be an important factor for studying the expected returns from companies. (Dividends Are Back!)

It is also important for the companies to pay dividends even for just saying that the dividend check is in the mail. This payment forms a strong direct message from the company to the shareholders about its being in strong financial shape. This also promises good performances in future. The fundamental financial strength of the company is indicated to the shareholders through dividends and regular increases in dividends. Earlier, prior to 1930s, there was no requirement on companies to send financial statements to shareholders, and then the payment of dividends was the major indication to shareholders about the strengths of the company. The situation has changed somewhat after the Securities and Exchange Act in 1934, and it has certainly made the information about companies more available to shareholders, yet dividends are still important as an indicator. (the Importance of Dividends)

In general it can be seen that developed companies still insist on paying dividends. At the same time, it would be wrong to say that companies not paying dividends are not making profits. One reason for not paying dividends can be that the company is finding better opportunities for investment, and that is the reason why it is withholding money from shareholders and investing the money in that opportunity. This is leading now to a situation where the companies which are called 'growth companies' do not pay dividends. At the same time, companies which are mature and pay dividends also retain funds in their own accounts for the financing of their own increase of business activity and look after any contingency that may come up. This leads many investors to keep a watch on dividend yield and that is the last annual dividend paid by the company divided by the current market price. (the Importance of Dividends)

The dividend yield directly measures the income in proportion to the investment. There are occasions when this can be seen to be low for a company as compared to its competitors in the same industry. This can talk well about the company or not so well about the company. It may be doing very well and the price is sustained by the future prospects of the company, and not earnings by shareholders. The second problem may be inability to pay dividends. At the same time, a high dividend does not indicate a company with excellent future - it may just be a sick company with a low market price. To judge this the important ratio of dividend coverage, which is the ratio of the company's net earnings to dividends, can be used. This will determine whether the earnings are well covered for dividend obligations. The ratio as already discussed is earnings per share divided by dividend per share. (the Importance of Dividends)

When this ratio is getting low and that is generally indicated in ratios below 1.5, then there is a good chance that the dividend in future will be curtailed. The investors should feel happy when the ratio is at 2 or 3. If the dividend is reduced, it is clear that the valuation of the share will also be lowered. For some companies the ratio has been seen to fall below 1 and that meant that the company was paying dividends from its earnings in earlier years. When the ratio is very high and that means that the ratio is above 5, then the investors should start finding out as to what is being done with the money. When the dividends are raised regularly it gives an indication to shareholders that the business is likely to be stable in future.

Let us talk about some companies who have done it in the past. Kimberley Clark raised the dividend by 13% during the first quarter of 2003, and that was an indication that it was not being troubled by the price war that it was going through then with Proctor & Gamble. (the Importance of Dividends) at the same time, quoted companies with dividends of 5% or more look very attractive, but one has to decide whether these dividends can be continued in future. This can be judged by dividend cover that the company has. Capital growth in invested shares is always liked, and has to be considered during a check on fundamentals. Some shares even turn around after being in trouble continuously for quite some time. (UK - Three stocks with secure dividends)

Getting back to Kimberly Clark, they said that they also wanted to increase dividends regularly over the next five years. This clearly indicates that if a company suddenly reduces its dividend, it…

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