The Importance of Dividends to Investors.
Dividends are cash distributions that companies pay out from their earnings to shareholders. Payment of dividend sends positive signal about the financial health of the company to investors. A company’s ability to consistently pay dividends and increase the payment amount over time provides good clues about the company’s fundamental strength and sustainability The proportion of earning companies pay out to investors as dividends depends on the stage of the business in the business life cycle. In most instances, mature, profitable companies pay dividends while younger companies tend to reinvest all or most of its profits into the business to ensure sustainability. Companies do not typically pay out their entire earnings as dividend, they retain some portion of their profits in cash to fund their business activities.
Dividend yield is the annual dividend income per share as a proportion of the current share price. This is a measure of the amount of income received in proportion to the share price. The dividend yield is used to compare companies within the same sector. If a company has a low dividend yield compared to other companies in its sector, it could be interpreted in two ways; the share price is high because of market expectation of growth prospect or the company cannot afford to pay reasonable dividends. Dividend can give investors a sense of what the company is worth.
The dividend discount model is a formula which explains the underlying value of a company. According to the dividend discount model, a share is
worth the sum of all its prospective dividend payments discounted to the present value. This is because dividend is viewed as a form of cash flow to
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