Question

Why would an investor ever buy stock in a firm with a low dividend yield? Using financial statement analysis of your own words.

Answer 1

The amount of dividend a company pays to its investors is the dividend yield. for example, A company paid $1 to each shareholder as dividend for holding $100 share.

dividend yield=$1/$100 *100 = 1%

mostly investors judge the capacity and worthiness of the company by evaluating the trend of company in paying dividends.

A general myth is if a company paying high dividend then it is a good company.

Dividend is not the sole criteria to judge the performance and worthiness of a company. For a sound investor, the capital appreciation is quite relevant and important factor to consider. Capital Appreciation is the rate of increase in the price of a share in the market. If a company with low dividend yield but high capital appreciation rate give more return than company with high dividend rate and low capital appreciation, then the investor earns well enough than latter or is compensated equally.

example-

COMPANY A (LOW DIVIDEND YIELD)

DIVIDEND YIELD- 5%, CAPITAL APPRECIATION OR GROWTH RATE - 25%, SHARE PRICE - $100

DIVIDEND THIS YEAR=5%*100=5

CAPITAL APPRECIATION - 25%*100 =25

RETURN TO INVESTOR= DIVIDEND+ CAPITAL APPRECIATION =30

COMPANY B (HIGH DIVIDEND YIELD)

DIVIDEND YIELD- 25%, , SHARE PRICE - $100

DIVIDEND THIS YEAR=25%*100=25

RETURN TO INVESTOR= DIVIDEND+ CAPITAL APPRECIATION =25

THUS THE RETURNS OF THE INVESTOR IN COMPANY A ARE MORE EVEN WHEN THE RATE OF DIVIDEND WAS 5%.

THIS HAPPENED BECAUSE OF GROWTH OR CAPITAL APPRECIATION.

WE CAN DIRECTLY LINK IT WITH RETENTION RATIO. RETENTION RATIO IS THE PERCENTAGE OF PROFITS/ EARNING COMPANY RETAIN WITH ITSELF. IT HAS THE DIRECT RELATION WITH GROWTH I.E. HIGHER THE PROFITS RETAINED HERE THE GROWTH AND VICE VERSA.

IF A COMPANY HAVE GROWTH OPPORTUNITIES IN THE BUSINESS ENVIRONMENT AND HAS THE POTENTIAL TO HAVE STRATEGIC ADVANTAGE OF THE OPPORTUNITY WITH RESPECT TO ITS INTERNAL STRENGTH THEN COMPANY RETAINS THE EARNING TO EXPLOIT IT.

THUS A COMPANY GIVING LESS DIVIDEND AND RETAINING A SIGNIFICANT AMOUNT OF EARNING IMPLICATE HIGHER GROWTH IN FUTURE WHICH CAN BE GOOD REASON FOR AN INVESTOR TO HOLD IN THE SHARE OR INVEST IN THE SHARE.