Question

What is the connection between the value of shares and dividends? How are they both different?

Answer 1

Dividend is the part of the earnings of the company paid out to its shareholders. Thus the alternative to payment of dividend is retention. Retained earnings increases the sustainable growth of the company.

The intrinsic value of per share is given by ...... Expected dividend / (ke - g)

Thus the value of share is primarily dependent on the dividends expected and anticipated growth in such dividends. This is espicially true for short term investors, interested in realised gains.

How are they both different?

Empirical studies, indicates that based on volume of business done in the financial market due to the entry of irrational biases among the investors, share value does not depend on the dividends. Efficient market discounts the shares value for all bad news and appriciates the shares for all good news. Thus movement above or below the intrinsic value is the reality that is observed in the markets.

Again for an assets backed up companies, there are huge capital gains which are not actually realised. For such companies, valuation based on earnings or dividends does not provide the meaningful value.

Situations of this kind indicates that dividends and share value are different. Infact method of valuation should be based on the purpose for which valuation is to be done. For example when a large portion or entire business is transfered to other business, assets based value is very important. Dividend based valuation is completely irrelevant. But for selling in small lots or in case of short term investors, dividend based valuation is important.