First smart thing I heard on CNBC this year
- Thread starter vladiator
- Start date
Dividends are usually paid by a mature company with not much room for growth (and therefore no real need for re-investment). As the MM theorem states (and I assume you know it by heart) there should be no difference whether a company pays dividends because an investor can turn around and with those dividends buy the company's shares on the market.
(Happy, Profitable and Healthy New Year's to All ET'ers!!)
I always try to imagine it was me. Let's say I have an idea to make a certain kind of toy robot. I need $200,000 to start production and distribution and I put in $50,000 of my own money. Now I can tell my millionaire friend if he gives me money, I will make him part owner of the toy robot business, and I will continue to invest all money earned through sales of my toy robots into making more and more toy robots, making them more quickly and in greater and greater numbers, indefinitely.
Or I can tell him if he gives me the money I need in order to start production, I will give him a certain pre-defined percentage of my profits whenever I generate any through sales of those robots.
Obviously most investors (like most humans) are idiots and care more for exponential growth projections 5 years into the future than being realistic and making a few bucks first, dividing up the profits, and then deciding where to take it from there.
But what it all comes down to is (tax issues aside) the difference a dividend makes is just the same as the difference a stock split makes, which is theoretically (financially) none, but practically a psychological boost.
You mixed up totally different arguments. Indeed, in the frictionless MM world, dividends are irrelevant and represent no signal etc (the idea of "homemade" dividends you are referring to).
MM theory aside, ignoring the agency theory/signalling arguments that are too voluminous to get into and are also beside the point in this context, I agree with you that dividends are paid by mature companies without much room for growth/reinvestment needs.
Effectively, the management is saying: "we have all this generated cash sitting around and we don't think we can provide as good a return by plowing it back as you investors can by investing it elsewhere..." That sounds like either the company is in the dying stage of its life cycle, or the management needs to be booted. In either scenario, why would you invest in it when even the management wich supposedly knows things we don't implicitely recommends that you withdraw part of your investment via dividends and are better off investing it elsewhere as the return prospects will be better.
Incidentally, if that's the message they are sending, why would anyone just take the portion that is paid out in dividends and invest it elsewhere leaving the remaining part invested in what mgmt signals is a subpar investment?
What if the company is a good investment, because it is able to generate significant returns from x amount of assets, but is unable to produce those same returns on assets above the value of x.
The company could then be a good investment because of the returns it generates on assets (value of which is x), and the admission that the company is unable to achieve those same returns on additional assets is not relevant.
The company could then be a good investment because of the returns it generates on assets (value of which is x), and the admission that the company is unable to achieve those same returns on additional assets is not relevant.