Dividends have become a hot topic of discussion in the world of investing. For many investors, dividends are not just a simple payment, but also a way to earn a stable passive income from their investments. Let's delve deeper into what dividends are, relevant theories, and their impact on investments.
What are Dividends?
Dividends are payments made by corporations to their shareholders, usually quarterly or annually, from their earnings. This payment is a way for companies to return a portion of their profits to their investors, providing them with a tangible return on their investment. Dividends are typically paid in cash, but they can also be distributed in the form of additional shares or other forms of compensation. This distribution will reduce retained earnings and available cash for the company, but distributing profits to shareholders is indeed the main goal of a business.
Relevant Theories of Dividends :
1. Dividend Irrelevance Theory (1958) by Merton Miller and Franco Modigliani. This theory argues that dividend policy is irrelevant to stock prices and company value. According to this theory, company value is determined solely by its underlying profitability and risk, and is not influenced by the dividend policy made by the company. Miller and Modigliani believe that investors tend to seek companies that provide such benefits, so companies can attract investors according to their dividend policy.
2. Smoothing Theory (1956) by Lintner. This theory focuses on the concept of stable dividend policy and company stock performance. Lintner found that companies tend to smooth earnings to improve stock performance and reduce the risk associated with unstable dividend policies. This theory also argues that company managers tend to adjust dividend policy to meet investor expectations and increase company value.
3. Bird in Hand Theory (developed by Myron Gordon and John Lintner). This theory argues that investors prefer cash dividends over promised capital gains in the future. Gordon and Lintner stated that investors value income in the form of dividends more than income expected from retained earnings. This view was given the name "bird in the hand fallacy" by Miller and Modigliani. Gordon and Lintner believe that one bird in hand is more valuable than two birds in the bush, which represents that investors prefer the certainty of dividends over the potential of capital gains.
4. Signaling Theory (developed by Rossi in 1997 and Ross in 1977). This theory argues that executives of a company with better information about their company will be motivated to convey that information to potential investors to increase the company's stock price. Signaling Theory explains that good financial reports are a signal or indication that the company has been operating well. Signaling Theory also explains that companies that distribute dividends can be a positive signal, while companies that do not distribute dividends can be a negative signal.
Impact on Investments :
Dividend policy can influence investment decisions. Companies that pay dividends regularly might be attractive to investors seeking passive income. On the other hand, companies that choose not to pay dividends or retain most of their earnings might be attractive to investors seeking long-term growth.
From the above reading, it can be concluded that dividends play a crucial role in the world of investing, not just as a source of passive income, but also as an indicator of a company's health and prospects. By understanding relevant theories and their impact on investments, investors can make better investment decisions according to their goals and preferences. However, as with all types of investments, it is essential to conduct thorough research and consult with financial professionals before making investment decisions.
