The Importance of Dividends from an Investors Perspective Finance Essay

The average investor will tell you that he or she invests for one reason and one reason only: to make a profit. No investor ever invests their money with the goal of making a loss. In fact, profitable earnings (also known as dividends) are usually one of the biggest factors that influence an investor’s decision A dividend is a cash payment from a company’s earnings; it isA announced by a company’sA board of directorsA and distributed among stockholders. In other words, dividends are an investor’s share of a company’s profits, given to him or her as a part-owner of the company. Aside fromA optionA strategies, dividends are the only way for investors to profit from ownership of stock without eliminating their stake in the company.A Dividend policies are the regulations and guidelines that companies develop and implement as the means of arranging to make dividend payments to shareholders. Establishing a specific dividend policy is to the advantage of both the company and the shareholder.

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Importance of dividend from investor’s prospective

Dividends are important for more than income generation: they also provide a way for investors to assess a company as an investment prospect. First, investors can use dividends to value a company using the dividend discount model (DDM). A share price can be seen as the current value of all future cash flows. The DDM discounts the projected dividend stream for the next few years back to a current value. If the DDM value is higher than the prevailing share price, the investor will buy the share. Second, the consistent payment of cash dividends gives investors an objective way of assessing that companies are cash generative, as it isn’t possible to pay dividends over the long term if there’s no cash in the bank. Investors should always evaluate a company on a total return basis that includes both capital growth and dividend income. In simple words Cautious investors look for dividends because,A [i] It reduces uncertainty (capital gains are uncertain).A [ii] Indication of financial strength of the company.A [iii] Need for income: Some invest in shares so as to get regular income to meet their living expenses

Importance of dividend from company’s prospective

One of the simplest ways for companies to communicate financial well-being and shareholderA value is to say “theA dividendA check is in the mail.” Dividends, those cash distributions that many companies pay out regularly to shareholders fromA earnings, send a clear, powerful message about future prospects and performance. A company’s willingness and ability to pay steady dividends over time – and its power to increase them – provide good clues about itsA fundamentals. In another word dividends are required because of the separation of ownership and management. Dividends are a signal of the sustainable income of the corporation: management selects a dividend policy to communicate the level and growth of real income because conventional accounting reports are inadequate guides to current income and future prospect Before corporations were required by law to disclose financial information in the 1930s, a company’s ability to pay dividends was one of the few signs of its financial health.

Despite the Securities and Exchange Act of 1934A and the increased transparency it brought to the industry, dividends still remain a worthwhile yardstick of a company’s prospects.A Typically, mature, profitable companies pay dividends. However, companies that do not pay dividends are not necessarily without profits. If a company thinks that its own growth opportunities are better than investment opportunities available to shareholders elsewhere, the company should keep the profits and reinvest them into the business. For these reasons, fewA “growth” companiesA pay dividends. But even mature companies, while much of their profits may be distributed as dividends, still need to retain enough cash to fund business activity and handle contingencies.A Generally dividends have many advantages for both investors and companies.

Do dividend policy helps to reduce agency theory?

Agency theory A theory explaining the relationship between principals, such as shareholders, and agents, such as company’s executives and directors. In this relationship the principal delegates or hires agent to perform work. The theory attempts to deal with two specific problems: first, that the goals of the principal and agent are not in conflict(agency problem), and second, that the principal and agent reconcile different tolerances for risk. Yes dividend policy helps to reduce agency problems according to Easterbrook (1984) where points out that dividends reduce the agency problem between shareholders and managers, monitoring management’s performance and facilitating market control, so that the market value of the firm will increase. This approach assumes that the dividend policy is used to mitigate the conflict between shareholders and managers. If part of the firm’s profits is not paid out as dividends, corporate managers may divert the cash flow for personal use or pursue unprofitable investment projects and that lead to increase agency problems.

Dividend payouts can be seen as means to reduce the free cash flow that managers can use at their own discretion (Jensen, 1986; Lang and Litzenberger, 1989). As a consequence, outside shareholders may have a preference for dividends over retained earnings so by dividends paid agency problems reduced. The agency models on dividends can be divided into at least two distinct groups. The first Range of theories considers dividend payouts as an outcome of the agency conflict between managers and shareholders, as well as between controlling shareholders and outside shareholders (La Port et al. 2000; Faccio et al. 2001). According to La Porta et al. (2000), dividend payouts are an outcome of the legal shareholder protection. Particularly, they find that firms in civil-law countries pay lower dividends than in common-law countries. La Porta et al. (2000) claim that under an effective legal system, minority shareholders use their legal power to force firms to pay out dividends. Contrary to this view, the second set of agency models argues that dividend payout policies are substitutes for governance problems in a firm (Easterbrook, 1984; Gomes, 2000).

Issues, challenges and problems associated with dividends policy. Why many companies listed in exchange failed to declare them as dividend Policy Company while they are generating big profit on annual basis.

There are many Issues challenges and problems associated with dividends policy and some these implications affected some companies and force them to undeclared dividends though they are generating high profit. Here is I am going to arrange these implications as a point with a brief elaboration due to limit word count which is 2000 words for this working paper. 1. Stability of Earnings.A The nature of business has an important bearing on the dividend policy. Industrial units having stability of earnings may formulate a more consistent dividend policy than those having an uneven flow of incomes because they can predict easily their savings and earnings. Usually, enterprises dealing in necessities suffer less from oscillating earnings than those dealing in luxuries or fancy goods.A 2. Age of corporation.A Age of the corporation counts much in deciding the dividend policy. A newly established company may require much of its earnings for expansion and plant improvement and may adopt a rigid dividend policy while, on the other hand, an older company can formulate a clear cut and more consistent policy regarding dividend.A 3. Liquidity of Funds.A Availability of cash and sound financial position is also an important factor in dividend decisions.

A dividend represents a cash outflow, the greater the funds and the liquidity of the firm the better the ability to pay dividend. The liquidity of a firm depends very much on the investment and financial decisions of the firm which in turn determines the rate of expansion and the manner of financing. If cash position is weak, stock dividend will be distributed and if cash position is good, company can distribute the cash dividend.A 4. Extent of share Distribution.A Nature of ownership also affects the dividend decisions. A closely held company is likely to get the assent of the shareholders for the suspension of dividend or for following a conservative dividend policy. On the other hand, a company having a good number of shareholders widely distributed and forming low or medium income group would face a great difficulty in securing such assent because they will emphasize to distribute higher dividend.A 5. Needs for Additional Capital. CompaniesA retain a part of their profits for strengthening their financial position.

The income may be conserved for meeting the increased requirements of working capital or of future expansion. Small companies usually find difficulties in raising finance for their needs of increased working capital for expansion programmes. They having no other alternative, use their ploughed back profits. Thus, such Companies distribute dividend at low rates and retain a big part of profits.A 6. Trade Cycles.A BusinessA cycles also exercise influence upon dividend Policy. Dividend policy is adjusted according to the business oscillations. During the boom, prudent management creates food reserves for contingencies which follow the inflationary period. Higher rates of dividend can be used as a tool for marketing the securities in an otherwise depressed market. The financial solvency can be proved and maintained by the companies in dull years if the adequate reserves have been built up. 7. Government Policies.A The earnings capacity of the enterprise is widely affected by the change in fiscal, industrial, labour, control and other government policies. Sometimes government restricts the distribution of dividend beyond a certain percentage in a particular industry or in all spheres of business activity as was done in emergency. The dividend policy has to be modified or formulated accordingly in those enterprises.A 8. Taxation Policy.A 

High taxation reduces the earnings of the companies and consequently the rate of dividend is lowered down. Sometimes government levies dividend-tax of distribution of dividend beyond a certain limit. It also affects the capital formation. N India, dividends beyond 10 % of paid-up capital are subject to dividend tax at 7.5 %.A 9. Legal Requirements.A In deciding on the dividend, the directors take the legal requirements too into consideration. In order to protect the interests of creditors an outsider, the companies Act 1956 prescribes certain guidelines in respect of the distribution and payment of dividend. Moreover, a company is required to provide for depreciation on its fixed and tangible assets before declaring dividend on shares. It proposes that Dividend should not be distributed out of capita, in any case. Likewise, contractual obligation should also be fulfilled, for example, payment of dividend on preference shares in priority over ordinary dividend.A 10. Past dividend Rates.A While formulating the Dividend Policy, the directors must keep in mind the dividend paid in past years. The current rate should be around the average past rat.

If it has been abnormally increased the shares will be subjected to speculation. In a new concern, the company should consider the dividend policy of the rival organisation. 11. Ability to Borrow.A Well established and large firms have better access to the capital market than the new Companies and may borrow funds from the external sources if there arises any need. Such Companies may have a better dividend pay-out ratio. Whereas smaller firms have to depend on their internal sources and therefore they will have to built up good reserves by reducing the dividend payout ratio for meeting any obligation requiring heavy funds.A 12. Policy of Control.A Policy of control is another determining factor is so far as dividends are concerned. If the directors want to have control on company, they would not like to add new shareholders and therefore, declare a dividend at low rate. Because by adding new shareholders they fear dilution of control and diversion of policies and programmes of the existing management.

So they prefer to meet the needs through retained earring. If the directors do not bother about the control of affairs they will follow a liberal dividend policy. Thus control is an influencing factor in framing the dividend policy.A 13. Repayments of Loan.A A company having loan indebtedness are vowed to a high rate of retention earnings, unless one other arrangements are made for the redemption of debt on maturity. It will naturally lower down the rate of dividend. Sometimes, the lenders (mostly institutional lenders) put restrictions on the dividend distribution still such time their loan is outstanding. Formal loan contracts generally provide a certain standard of liquidity and solvency to be maintained. Management is bound to hour such restrictions and to limit the rate of dividend payout.A 14. Time for Payment of Dividend.A When should the dividend be paid is another consideration.

Payment of dividend means outflow of cash. It is, therefore, desirable to distribute dividend at a time when is least needed by the company because there are peak times as well as lean periods of expenditure. Wise management should plan the payment of dividend in such a manner that there is no cash outflow at a time when the undertaking is already in need of urgent finances.A 15. Regularity and stability in Dividend Payment.A Dividends should be paid regularly because each investor is interested in the regular payment of dividend. The management should, inspire of regular payment of dividend, consider that the rate of dividend should be all the most constant. For this purpose sometimes companies maintain dividend equalization Fund.

Conclusion

When a company earns profits from operations, management can do one of two things with the profits. It can choose to retain them – essentiallyA reinvestingA them into the company with the hope of creating more profits and thus further stock appreciation. The other alternative is to distribute a portion of the profits to shareholders in the form of dividends. It is important for investors and companies to consider the benefits that dividends offer and how easy it is to include dividend-paying stocks in any portfolio. Dividend paying stocks offer numerous advantages, including: Attractive Returns:A Dividends paid are part of total return. Companies that pay dividends are usually historically stable. Less Volatility:A Dividends help lessen the potential fall of a company’s stock price, thereby reducing volatility. Increased Yield:A Dividends provide income (however they are only a small part of an investment’s total return). Furthermore dividend policy reduces the agency problems.

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The Importance Of Dividends From An Investors Perspective Finance Essay. (2017, Jun 26). Retrieved August 11, 2022 , from
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