Determinant 2: The Expected Dividend payout

Determinant 2: The Expected Dividend payout

The amount of dividends you receive at each payout – as contrasted to their growth rate – is readily understandable as being an important factor in determining a stock’s price. The higher the dividend payout, other things being equal, the greater the value of the stock. The catch here is the phrase other things being equal. Stocks that pay out a high percentage of earnings in dividends may be poor investments if their growth prospects are unfavorable. Conversely, many companies in their most dynamic growth phase often pay out little or none of their earnings in dividends. But for two companies whose expected growth rates are the same, you are better off with the one whose dividend payout is higher.

Beware of the stock dividend. This provides no benefits whatever. The practice is employed on the pretext that the firm is preserving cash for expansion while providing dividends in the form of additional shares. Stockholders presumably like to receive new pieces of paper – it gives them a warm feeling that the firm’s managers are interested in their welfare. Some even think that by some alchemy the stock dividend increases the worth of their holdings.

In actuality, only the printer profits from the stock dividend. To distribute a 100 percent stock dividend, a firm must print one additional share for each share outstanding. 

He is happiest, be he king or peasant, who finds peace in his home (Johann Wolfgang von Goethe)

But with twice as many shares outstanding, each share represents only half the interest is the company that it formerly did. Earnings per share and all other relevant per-share statistics about the company are now halved. This unit change is the only result of a stock dividend. When Great Britain replaced one shilling with five new pence, the English, being a sensible people, did not celebrate. Neither should stockholders greet with any joy the declaration of stock splits or dividends – unless these are accompanied by higher cas dividends or news of higher earnings.

The only conceivable advantage of a stock split (or large stock dividend) is that lowering the price level of the shares might induce more public investors to purchase them. People like to buy in 100-share lots, and if a stock’s price is very high many investors will feel excluded. But 2 and 3 percent stock dividends, which are so commonly declared, do no good at all.

The distribution of new certificates for stock dividends brings up the whole concept of actual certificates of ownership. This is an incredibly cumbersome and archaic system and should be eliminated. Records of ownership could easily be kept on the memory disks of large computers. Some bonds are actually recorded that way now. If stockholders could rid themselves of their atavistic longing for pretty embossed certificates. Wall Street could reduce its paperwork burden, commission rates might be reduced, and environmentalists could congratulate themselves on another victory.

Now let’s sum up by printing the second rule:

Rule 2: A rational investor should be willing to pay a higher price for a share, other things being equal, the larger the proportion of a company’s earnings that is paid out in ash dividends.