Dividends Don’t Matter? Count Me Skeptical
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Whether in a business school classroom or at some other point during your journey as an investor, you’ve heard it said. The concept is rooted in the influential Modigliani-Miller theorem. It has since morphed into the harshly named “dividend irrelevance theory.”
The argument goes like this: A company’s value (and stock price) is driven by its ability to earn a profit and grow its business. Its dividend policy is irrelevant at best. In some cases, paying dividends could hurt the stock.
Is it true? Let’s explore this idea further.
As a shareholder, you are a partial owner of a business. You want the management of that business using its investment capital and earnings in the best way possible. Now, management has a few choices of what to do with that capital. They can pay down debt, reinvest in the company, make an acquisition, buy back stock, or pay a cash dividend.
In theory, paying dividends could be detrimental. If a company can achieve a high return for shareholders by deploying that capital to grow the business or acquiring another one, it makes sense to do that in lieu of paying a dividend. And if a company has substantial debt, they could be sacrificing a healthier balance sheet and financial position by paying out dividends.