Question

How relevant and practical do you feel dividend theory is in assessing corporate performance?

Answer 1

Dividend theory focuses that dividend is a part of the profits of the company and these are to be paid to the shareholders and if a company is regularly paying on its dividends, that means that company is financially sound and it will grow in future as well as its share is going to rise.

There are generally two type of companies which believe in paying sustainable dividend and other which do not believe in paying dividend and rather reinvest their profits.Companies which pay dividend are the mature kind of companies and they are highly financially sound and they have a lot of cash flows in their hand and Liquidity on their books. Another reason for distribution of dividend is because it provides them to distribute a part of the profit to the shareholders as well as to provide the indication to the shareholders that the company is continuously making profit and it is on the growth trajectory. Dividend payments often lead to price increase in shares.

Other types of company which do not believe in paying out dividend are generally growth companies which are in the growth stage of their life cycle and they want to build on to their profits and they invest into their own business so they do not opt for paying dividend to the shareholders, They rather re-invest the profits into the business and generate more rate of return, so this type of companies are generally growth companies.

I am of the opinion that paying out regular dividend on growing basis is highly important for having a reputation of sustainable company and it also provides with a premium to the share price as investors feel secure in investing into such companies and they also generate a uniform stream of cash flows so this type of regular dividend payments helps company to stabilize itself as a company with strong fundamentals.