Dividends or no Dividends

Dividend policy is the determination of the proportion of profits paid out to shareholders. The issue is whether shareholder wealth can be enhanced by altering the pattern of dividends not the size of dividends overall. If dividends over the lifetime of a firm are larger then the value will be greater. The board of directors are empowered to recommend the dividend level but it is the right of shareholders as a body to vote at the AGM whether or not it should be paid. Dividends can only be paid out of accumulated distributable profits and not out of capital. The proportion of after-tax earnings paid as dividends varies greatly between firms, from zero to more than 100 per cent. Some shareholders prefer to have a regular income from shares in the form of dividends, these shareholders tend to be people who have invested their savings and need regular income to supplement their income. Whereas other investors are seeking long-term benefits and want to see their share value increase that can then be sold at some time in the future. Some people believe that firms that pay dividends are less risky because you get some money back each year. This belief is common in the popular press and the dividend value can have some effect on share price. Dividends are hard enough to explain when they occur in isolation, a combination of dividends and the simultaneous raising of new capital is very confusing. Yet the simultaneous or near simultaneous payment of dividends and raising of new capital are common in business.

Dividends do not directly reveal the prospects of the firm, so any message they send may be ambiguous. Prosperous firms may withhold dividends because internal financing is cheaper then issuing dividends and floating new securities. Also dividends do not distinguish well-managed prospering firms from others. Someone who observes an increase in the dividend has no good way of telling whether this is a signal of good or bad times. These are hard to evaluate because its difficult to obtain a measure of unanticipated changes in the levels of dividends, and only unanticipated changes could change the prices of shares. Moreover an increase in dividends could be caused either by an increase in the firms profits (implying higher stock prices) or by the commencement of disinvestment as the firm has fewer profitable opportunities (implying lower stock prices). This is consistent with the observation that no-dividend (or low-dividend) stocks are usually “growth” firms, which are regularly in the capital market, and with the impression that such firms start paying dividends only when the rate of their growth has been reduced.

Miller and Modigliani (M&M) said that dividend policy is irrelevant to share value if a few assumptions are made. These assumptions are: no taxes, no transaction costs, same interest rate for borrowers and lenders, all investors have access to information and investors are indifferent between dividends and capital gains.

But in the real world all these assumptions cost and if there is not enough money left to fund future projects the firm would take money from shareholders through a rights issue and this also cost with admin and legal fees, advertising, underwriting fees, brokerage fees and of course taxes.


                                            Apple Inc

                                            Source: Google finance

To bring us up to date, Apple last paid a dividend in 1995. They have now announced that from 30^th September 2012 they will pay a quarterly dividend of $2.65 per share. Was this due to the change in governance rules?. Did the shareholders pressure for a dividend? or did the management get soft-hearted? So it just goes to show that regular dividends are not the always the way to go. I wish I had had the forethought to buy some shares in Apple, but could Apple have now reached a peak in growth and performance.

Ten years ago Apple shares were worth about $10 dollars, now in 2012 after a successful 18 months of sales of Ipad and Iphone they are valued at over $600 dollars. It was revealed that Apple has a cash mountain of $100 billion. Could this be burning a hole in the proverbial pocket? Additionally Apple are to buy back up to $10 billion worth of shares starting in their next financial year. What is the reason for the buy back? Do they want more control over the business? We will just have to wait and see!

Sources: Baker, M. 'A catering theory of dividends'., Easterbrook, F.H. 'Two Agency-Cost Explanations of Dividends', BBC news March 2012.,Google Finance., Arnold, G.