‘The harder we look at the dividend
picture, the more it seems like a puzzle, with pieces that just don’t fit
together’. This a great quote by Fischer Black represents my feelings towards
dividends, a company that pays the most dividends is the best on to invest in
right? There are so many theories on the correct way for businesses to give
dividends it’s hard to see the wood from the trees.
I’m only going to briefly discuss a couple
of these theories otherwise I’d probably be able to write a book with them all.
The first theory I’ll mention is my two least favorite people I talked about last
week Modigliani & Miller and their theory of dividend irrelevance. It
completely fathoms me that their theories are still talked about because each
one I have come across so far can’t be related into the real world (again this
theory doesn’t count tax!!!!) so in reality is completely and utterly useless.
Their idea with this theory is that dividends is a residual payment after NPV
projects are financed, basically to assume each year a businesses opportunities
completely change to the previous year and will fluctuate for good to bad. Thus
with this policy shareholders don’t know the level of dividends (if any) they
will receive each year.
Now after I’ve just insulted Modigliani
& Miller, I’ll just mention the thing I like about this theory. I like that
it takes into consideration the fact that paying dividends is wasting money
that could be used within the company for R&D. For example Google don’t pay
any dividends to their investors and share prices still continuously rise.
However people know that when they invest into Google they won’t receive
dividends; with M&M’s approach it changes every year and for a shareholder
the unknown of what’s coming next sits uncomfortably with most.
The other theory I’ll talk about in this
blog post is signaling; this is where investors see dividends as giving
information on company’s performance/prospects. Following this theory high
dividends= good news and low dividends= bad news.
An example of this theory work is with
Barclay’s earlier this week they announced a cut in dividends to put the money
towards restructuring and capital resilience. A chief analyst at Cenkos even
say’s the cuts are justified for the success of the company in the
restructuring. However investors have seen this slash as a negative and thus
led to share prices falling by 8%. This situation is proving that signaling is
used in the market and even with analyst saying that this cut is helping build
the future of Barclay’s, investors have automatically taken the slash as there
must be bad news coming soon.
However an example of this working against
the investor is last summer BHP Billiton announced their worst profits in a
decade but still increased their dividends by 2%. This lead to the share price
rising 5.5% this looked like BHP Billiton was sending the signal of ‘don’t
worry we will turn things around’. In reality they were up shits creek without
a paddle and have now scrapped dividends. BHP Billiton’s example shows how
signaling can be manipulated to give a certain impression of the company.
So back to the question that Fischer
Black’s quote left me with, I don’t necessarily think that the bigger the
dividends the more successful the company is. I believe that a lot of
shareholders have an extremely short-term view when it comes to investment and
businesses try to appease this. Taking the dividends might seem great at the
time but surely receiving a smaller dividends, letting the company spend some
of that money within the business and in the long term having a greater return
on the share price is better. Companies that pay’s higher than average
dividends leaves me with a question of why aren’t they investing that money?
It’s a hard area making sure the company
has the correct dividends policy, the main thing to remember with these
theories is non of them are mutually exclusive and so a business can use a mix
to find the best policy for themselves.
Thank you for reading my ramblings please
feel free to leave any comments.
No comments:
Post a Comment