Dividend Valuation: dividends are the boldest way that a company can announce their performance and earnings potential.

Dividend Valuation

Valuing a company based on its ability to provide regular and increasing dividends is a worthy practice.  This is because dividends represent the only real gains of investors in a company where they have stake.

• Either in cash or asset payout, dividends are the boldest way that a company can announce their performance and earnings potential.  

• Unlike market value which indicates the idle wealth of shareholders, dividend valuation injects the past, present, and future earnings performance of the firm as it cannot distribute dividends without any excess money to finance operations and expand.  

• On this ground, however, growing companies are likely not regularly distributing dividends.  This is caused by their interests to reinvest excess earnings and concentrate them to growth prospects rather than disbursed to individual investors.

The dividend policy of a firm tells so much of its life cycle. 

• When companies reached their maximum growth potential, dividend payouts tend to be a practice.  This is because the firm wants to retain investors and encourage them to maintain their investment even growth had stopped.  

• Investors can use dividend policy as reference whether a firm is facing financial difficulties and failed to produce planned profits.  This scenario is observed in cases of dividend payment cuts.  

• On the other hand, consistent and even rising dividend payment may also represent a negative feature like financing such payments with debt.  In effect, the benefits of dividends are waived by costs and risks of debt and interest financing.  

• With dividends coming directly from earnings or buyback programs, continuity and regularity of its distribution minimizes the probability that managers will manipulate accounting data particularly earnings.

Computing for corporate value, specifically common shares, using dividends is done in at least three ways as there are numerous models that have been developed.

• Zero and constant dividend growth is a formula appropriate for mature companies which can minimally expand their operations.  Discount rate and expected dividend payout are required variables.  Although with less uncertainty and greater potential to accurately value the firm, growth potential is not present.

• The second formula offers the ability to estimate future dividend growth of a firm.  As this relies on historical data of actual dividends, the quality of valuation is a function of the quantity of the periods that have been collected.  If the firm do not have an ample historical data, results may not likely be as statistically significant as with a sufficient data under study.

• Lastly, irregular dividend to be followed by constant growth is apparently a version that follows the corporate life cycle (e.g. from growth to mature years).  This formula requires the beta or the degree of share sensitivity to market changes as well as the forecasted dividend growth.  This computation requires extensive market research and analysis which is vital to investing but troublesome to some investors.

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