If there are no attractive investments, should the company increase the dividends and give money to shareholders?
Since the beginning of 2014, the house building sector has grown significantly by about 60%. More people have been investing in this industry due to this. Most investors also received special dividends. This would have made the investors happy but was this really a wise move by the companies?
Extraordinary dividends can be declared every now and then but I believe a company should make sure that they are in a stable position first. Dividend policy aims to maximise shareholder wealth and are very important when it comes to communicating how the company is doing. If a company does not pay any dividends to shareholders, they might get the wrong message and think that the company is not doing well at all but it may just be that they are reinvesting the money. On the other hand, if companies continuously give shareholders high dividends, they might wonder why the company is not reinvesting their money at all - investment capability drives growth which would increase the share price.
Share prices have suffered recently and analysts have recommended that investors should not buy shares from the house building market right now. Current market conditions are claimed to be "too good to be true" so their valuations could suffer if the gross margins are affected negatively. Could the companies in this sector have avoided the unfavourable conditions they are faced with right now if they had not paid extraordinary dividends earlier? I believe that they could have saved their money then and just paid shareholders an average amount of dividend so that they could continue paying dividends with their retained earnings even when things are potentially going downhill for them. When it comes to paying dividends, it does not necessarily have to be on the current year's profits.
Let's consider what Modigliani and Miller's opinions are on this. We have to understand that they did not actually create the dividend irrelevance theory but just defined it. In 1961, they argued that the share prices were determined by future earning potential and not by the dividends paid now - share value is set by investment policy. They believe that if dividends are never paid, the company's shares are worthless but is this really true? What if the companies found a really good investment deal one year and decided to go with that option rather than giving their investors a high dividend? I believe that the right balance between paying dividends and reinvesting is very important.
As always, Modigliani and Miller (1961) made some key assumptions with the biggest one being that there is no tax - however if you look at the political risks of dividend policies, the assumption there is that if a business is making an unusually large profit, the government would get involved and implement additional taxes. Therefore, can Modigliani and Miller's theory really be applied to real life? I don't think so! In fact, I don't think any one theory can explain whether companies should pay dividends or not.
Some analysts have argued that gross margins may rise next year before they start to decline again in the future. Updates about trading for house builders may look appealing, we have to remember that they are very vulnerable to change.
What is the best way for a company to react to profits? I believe it depends on whether the profits are low or high. Managers may try to maintain dividends by using retained earnings when profits are low - the aim is to send a signal to shareholders claiming that the drop is only temporary. On the other hand, if their profits are very high, directors of the companies may be more cautious about it and not declare a huge dividend because they may not be able to maintain the rate in the future and cuts in dividends could lead to shareholders being more uncertain about their investments.
What do you think is the best way for a company to react for fluctuations in profits? Let me know in the comments below.
Some analysts have argued that gross margins may rise next year before they start to decline again in the future. Updates about trading for house builders may look appealing, we have to remember that they are very vulnerable to change.
What is the best way for a company to react to profits? I believe it depends on whether the profits are low or high. Managers may try to maintain dividends by using retained earnings when profits are low - the aim is to send a signal to shareholders claiming that the drop is only temporary. On the other hand, if their profits are very high, directors of the companies may be more cautious about it and not declare a huge dividend because they may not be able to maintain the rate in the future and cuts in dividends could lead to shareholders being more uncertain about their investments.
What do you think is the best way for a company to react for fluctuations in profits? Let me know in the comments below.
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