Sir I just completed a class of FCF valuation in equity and you linked that part to capital budgeting chapter that in the years when the EPS is high then to the board may keep the dividends constant to maintain the stability of the dividends and vice versa.
Sir I think this is similar to the Earnings management part in FRA evaluation of financial reports.
But then earnings management is a biased accounting choice then sir for maintaining the stability of dividend the financial reports will lack the decision usefulness.
Is my thinking correct?
PFA Sanjay Sir’s audio response
Is the same also true in case of EPS being low and company like Infosys still maintaining Dividend to give stable income to investors dependent on same?
Historically, dividends have always been very sticky. Even in the worst of times companies have not reduced their dividends , because it is viewed as a negative sign by investors. If a company reduces it’s dividends, expectations get build in the market that dividends would be lower in the future as well so share price goes down. That said there may be no impect on the value, as the bad time gets over company may raise dividend again and investors will realise their mistakes and price will go up back to the previous levels. It is taught in the corporate governance theories that the objective of running a company is to maximise the value and hope for convergence between value and price.
So “dividend stability” should not be a cause of concern for the managment as reducing dividend in a bad year may not impect value significantly. But this is not how things heappen in the real world , even if a company reduces dividends only for good of the company, share price falls and that falling share price takes down the managment team with it as well. As it heappend with firms like British petroleum. And because no one wants to get fired, when it come to dividends management start to focus on price and not value. And actually that is why dividends have been sticky.
hi Akshatvijay
i have a further doubt that. if a company follows dividend stability, for example in a down cycle, company profits are low and as we all know retained earnings are best used to fund the future projects of the company. now profits are low and now if we maintain the dividend payout, the firm might not be able to fund its future projects or might have to take a loan for the further projects or raise further equity. how is that a wise choice as paying dividend at the cost of the future of the company. and in the long run if the company raise new funds. it will be as good as raising debt/equity to give dividends. that should be counted as a negative signal.
just wanted some further clarity as what i understand is- a company giving out dividends means that company have ample funds to for its future project and choose distribute the extra income. but if there is no extra income the dividends should be lower.
Historically, dividends have always been very sticky. Even in the worst of times companies have not reduced their dividends , because it is viewed as a negative sign by investors. If a company reduces it’s dividends, expectations get build in the market that dividends would be lower in the future as well so share price goes down. That said there may be no impect on the value, as the bad time gets over company may raise dividend again and investors will realise their mistakes and price will go up back to the previous levels. It is taught in the corporate governance theories that the objective of running a company is to maximise the value and hope for convergence between value and price.
So “dividend stability” should not be a cause of concern for the managment as reducing dividend in a bad year may not impect value significantly. But this is not how things heappen in the real world , even if a company reduces dividends only for good of the company, share price falls and that falling share price takes down the managment team with it as well. As it heappend with firms like British petroleum. And because no one wants to get fired, when it come to dividends management start to focus on price and not value. And actually that is why dividends have been sticky.