Monday, 30 January 2012

Dividends generating signal about what the management is thinking.

Today I was going through Reading 31 which is related to dividend and share repurchase. The theories presented in the topic are interesting especially the one related to the behaviour of clients. The growth investors consider the declaration of dividends as a negative signal and the investors who want steady dividend and have invested in a company which continues to increase dividend amount or maintains a stable payout ratio consider the cutting of the dividend as a negative signal.

Empirically the studies have shown that declaration of dividend is considered to be a positive signal as it reflects a feeling that the future earnings, based upon which the company is valued, are higher and that's why the company has declared a dividend and vice versa but this is not true for all sort of investors. When in 2003 Microsoft was deciding to declare dividend several investors were curious as investors, seeking growth, had invested with the aim that the company would grow but it could give a perception that the company had no future projects to hold cash.

As an analyst it is necessary to know about the capital structure of the company. The reinvestment opportunities, growth opportunities available to the company, the client preference and the legal and financial environment. Based upon these aspects the dividend policy of the company must be evaluated.

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