Dividend Relevance or Dividend Irrelevance?

Welcome back everyone! I hope my last few posts have kept you all in tack with everyday finance and questions that may crop up in the finance world. This week I am bringing you another view from Modigliani & Miller. Stay tuned...

Lets first talk about what are the meanings behind dividends then we will on to see if we companies should pay dividends or reinvest. Paying out dividends shows that the company provides certainty about the company's financial well-being. Some see this as a reward but other companies can show this in different ways such as increasing wealth to use cash or retained earnings and to invest this back into the company for growth and innovation. As much as dividends can be seen as a pretty picture of course Modigliani & Miller did not agree to this. M&M declared dividends to be irrelevant because investors could home brew their own dividends by selling from or borrowing against their portfolios, (Easterbrook, 1984). They argued that dividends represents a residual payment after investing in projects with positive NPV projects. How do we all feel about this? How would you like to be paid as a shareholder?

Modigliani and Miller believe that dividend irrelevance leads to companies spending a great deal of time pondering an issue about which their stockholders are indifferent. Let's talk about a company that support the M&M  theory. Google a large company that have used their earnings to invest into the company. 2014, Google invested $9.8 billion into research and development which lead to a constant increase in revenue but yet no dividends paid out. How do we all feel about this? Do we support the M&M dividend irrelevance theory? Has this left Google in the deep end? No! Google's share price has risen about $65 billion! Recently having a 16.3% jump. Its $468 billion market capitalization makes it the second most valuable U.S. stock. This was all done through investment policy theory? Can we finally say M&M theory may be realistic? 

Large companies such as Amazon do not pay dividends as they invest a lot more. This takes us back to the way M&M support 'dividend irrelevance'. Let's talk about Berkshire Hathaway... They have now generated more than $10 billion in free cash flow in each of the past four years, after never having generated more than $7.2 billion in free cash flow in any prior year in its history. The company's gross cash balance reached $47 billion at the end of 2012. Companies such as Google, Amazon, aggressively are investing in future growth initiatives. There are companies out there such as Gilead Sciences that have rising free cash flow that now exceed capital spending, that do not pay dividend then we ask our self why? BUT soon they shall be... In the past few years, Gilead has taken advantage of a weak stock price to buy back more than 300 million shares. So can we see the M&M theory to be a positive theory? What do you all think?

As much as the Modigliani and Miller theory of dividend irrelevance may seem positive it also has its flaws. Shareholders will have to be waiting for long term awards such as capital gains? Can we see this as a risk of uncertainty? hmm... I think so! Markets can be seen as not perfect, meaning we will not always know what a company may face next. Companies pay out dividends in cold, hard cash. These are not paper profits that can disappear just like that. Dividends are money in your pocket, and after they're paid they can't be taken from you. So would we not want the cash in our pockets? rather than the M&M theory of dividend irrelevance. Investors gain confidence in the consistency and growth of the company when they are paying out regular dividends which then leads to an increase in the share price of the company.

Ok people lets wrap this up enough of Modigliani & Miller. There are supports for both arguments of dividend relevance and irrelevance. As we have been proven large companies out there are investing can increase shareholder wealth and other companies in the world that pay dividends can also do the same. I personally think it depends on the business sector itself, as you can see there are a lot of large successful companies out there that do not pay dividends but maybe this is the best theory for their particular company? I feel there is not a right or wrong way of dividends as both have been proven to be successful in different ways. Companies need to decide whether paying dividends would be the best option for the company or not!

Invest or Dividends?

It's a wrap!

RS.

Comment below with your views & questions!