Dividend

What is Dividend?

The dividend is a common type of “reward” from the company to its shareholders (people holding the company’s stocks). It is a “win-win” strategy because the shareholders can receive monetary returns, and at the same time, the company can gain shareholders’ trust.

How Does It Work?

Dividends are decided by the company’s board of directors. The company will split a part of its retained earnings to reward investors who hold its stocks.

Why Is It Important?

Besides the benefit it brings to both the investors and the company, dividends are also essential to many financial models, including the Gordon Model. Gordon model helps derive the cost of equity (Re) in Weighted Average Cost of Capital (WACC).

Many value investors believe that a company’s price should be the sum of all future anticipated dividends, discounted as the risk-adjusted cost of equity. In Gordon Model, dividends are considered as the cost of equity because it is a “cost” for a company in order to gain interest and trust from the investors. In addition, it also represents the opportunity cost for the investors if they invest this money into other types of equity (i.e., other companies’ stocks) instead.

Gordon Model was first introduced by M. J. Gordon in a paper entitled “Dividends, Earnings and Stock Prices,” Review of Economics and Statistics.

Myron J. Gordon. Photo Source: https://www.theglobeandmail.com/news/national/hatched-at-mit-in-1959-the-gordon-equation-soon-grew-into-an-important-tool-for-investors/article1389720/?page=all

Why Some Companies Do Not Have Dividend Payout?

Each public company’s historical dividend rate can be found at https://finance.yahoo.com/. Companies with high dividend rates are usually the ones considered “value stocks”. It is noteworthy that many companies do not pay dividends (Tesla, for example). This is especially common among tech stocks and growth stocks. Companies that do not pay dividends would rather re-invest their retained earnings in their own businesses, such as in research and development (R&D). From a long-term perspective, this action is beneficial for the growth of the companies, because it increases the business’s productivity and competitiveness (which is another way, is also a reward for investors).