What Is Dividend Irrelevance Theory?

Dividends are distributed from a company’s profits to its 澳洲幸运5开奖号码历史查询:shareholders as a reward for investing in the company. Many companies pay dividends instead of reinvesting the money to generate earnings.

Some common views hold that dividends help a company’s 澳洲幸运5开奖号码历史查询:stock price to rise. Dividend irrelevance theory posits that 澳洲幸运5开奖号码历史查询:dividends don’t affect a company’s stock price. It argues dividends can 🌼hurt a company’s long-term competitiveness.

The theory was developed by economists 澳洲幸运5开奖号码历史查询:Merton Miller and 澳洲幸运5开奖号码历史查询:Franco Modigliani in 1961. The duo are also responsible for the 澳洲幸运5开奖号码历史查询:Modigliani-Miller theorem. Both were awarded the Nobel Prize in Economics.

What the Theory Argues

Dividend irrelevance theory suggests that dividends should have little to no impact on a company's stock price. The theory argues that a company’s ability to earn profit and grow determines a company’s market value and drives the stock price.

Dividend irrelevance theory argues that dividends don’t benefit 澳洲幸运5开奖号码历史查询:investors and can hurt a company’s financial health. If markets perform efficiently any dividend payout will lead to a decline in the stock price by the dividend amount. If the stock price was $10, and the company paid a dividend of $1, the stock would fall to $9 per share. Holding the stock for the dividend achieves no gain since the stock price adjusts lower for the same amount.

Dividends and Stock Price

Stocks that pay dividends, like many established companies called 澳洲幸运5开奖号码历史查询:blue-chip stocks, often increase in price by the amount of the dividend as the 澳洲幸运5开奖号码历史查询:book closure date approaches. Although the stock can decline once the dividend has been paid, many dividend-seeking investors 澳洲幸运5开奖号码历史查询:hold tဣhes🉐e stocks for consistent dividends, creating an underlying level of demand.

The stock price is driven by more than 澳洲幸运5开奖号码历史查询:the company’s dividend policy. Analysts conduct valuation exercises to determine a stock’s 澳洲幸运5开奖号码历史查询:intrinsic value. These often incorporate factors, such as:

• Dividend payments
• Financial performance
• Qualitative measurements, including management quality, economic factors, and an understanding of the company’s position in the industry

Paying for Dividends

A company may take on debt, like issuing bonds to investors or borrowing from a bank’s 澳洲幸运5开奖号码历史查询:credit facility, to make cash dividend payments. Companies that have made acquisitions may hold significant debt on their 澳洲幸运5开奖号码历史查询:balance sheets. The 澳洲幸运5开奖号码历史查询:debt-servicing costs or interest payments can be detrimental. Excessive debt can prevent companies from accessing more credit.

Proponents of dividend irrelevance theory would argue that a company with substantial debt that insists on paying dividends is hurting itself since dividend payouts could have paid down debt. Less debt leads to favorable credit terms and options to reduce debt-servicing costs.

Debt and dividend payments might prevent the company from making investments that increase earnings in the long term. If a company is not investing in its business through 澳洲幸运5开奖号码历史查询:capital expenditures (CAPEX), its valuation may decline as earnings and competitiven🐼ess erode.𒅌 Capital expenditures include purchases of buildings, technology, equipment, and acquisitions.

Portfolio Strategies

Despite the dividend irrelevance theory, many investors focus on dividends when managing 澳洲幸运5开奖号码历史查询:portfolios. For example, a current income strategy seeks to identify investments that pay above-average distributions with a relatively 澳洲幸运5开奖号码历史查询:risk-averse stance.

Strategies focused on income are usually 澳洲幸运5开奖号码历史查询:appropriate for retirees or risk-averse investors. These ♍income-seeking investors buy stocks in established companies with a track record of consistently paying dividends.

Blue-chip companies like Coca-Cola, PepsiCo, and Walgreens Boots Alliance, 澳洲幸运5开奖号码历史查询:generally pay steady dividends. Dividends can help with portfolio strategies centered around the 澳洲幸运5开奖号码历史查询:preservation of capital. If a portfolio suffers a loss from♔ a decline in the stock market, the gains from dividends may help offset those🌺 losses.

The Bottom Line

Dividend irrelevance theory maintains that dividend payments don’t impact a company’s stock price. The theory was developed by economists Merton Miller and Franco Modigliani, both Nobel laureates. Critics of the theory argue that a company’s ability to pay out regular dividends signals financial strength and sustainability to investors, which can positively imp♈act a stock’s price.