Dividend payouts boost share price and investor confidence

American businessman John Rockefeller famously said “do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” Since the onset of the Covid-19 pandemic the global markets have faced disruptions affecting revenues of most businesses.

Many securities exchange-listed companies have slashed dividend payouts to shareholders. Interestingly, during the year 2021, most of the NSE-listed companies were back on track with performance as witnessed from quarterly reports of the first three quarters.

Yet some are holding back on announcing dividends at an expected level or entirely. More than half of the stock prices of listed companies at the Nairobi Securities Exchange have yet to return to the pre-Covid-19 levels. With regard to the banking counter alone, for instance, some blue-chip listed financiers issued lower than expected final dividends for year-end 2020 while some declared nil dividends.

Some listed banks have declared interim dividends for their shareholders during the third quarter of the year 2021, while a select few with a history of paying good dividends have slashed payout despite good performance.

This is the case with most counters, not just banks. What is the management of the listed companies doing to counter this uncertainty and build investor confidence?

Dividends 

The argument of the uncertainty of dividends is favoured by various schools of thought. Investors prefer cash dividends in current times to those in the future. They prefer current dividends as well as a gradual increase in the value of the stock.

Stakeholders often act upon the principle “a bird in the hand is worth two in the bush” and for this reason, are willing to pay a premium for the stock with a higher dividend rate just as they discount the one at the lower rate. Economist Myron Gordon had earlier given this view that dividend is irrelevant, that is, it has no impact on the value of the share when the internal rate of return is equal to the cost of capital. He later modified this assumption and came to the conclusion that the dividend policy definitely affects the value of the share.

This argument is known as “the bird in hand” school of thought. The logic behind this argument is that investors discount the distant dividend at a higher rate of return than the near dividends. The payout of dividends is a strategy that can help organisations raise their share prices by generating demand for their shares.

Gordon through his studies of dividends concluded that the increase in the retention of earnings will result in a lower value of the share. It is based on the assumption that investors are risk-averse and they considered the distant dividends less certain than the near ones.

During times of uncertainty, the investor looks for the information content of dividends and signalling by the firms. According to the dividends signalling hypothesis, dividend changes during announcements trigger share returns because they convey information about the management assessment on the firm’s future prospects.

Firms should contemplate during periods of lower earnings to utilise part of the reserves to pay shareholders. By way of announcing the dividend action, the companies signal the investors. Usually in the stock market will see an increase in stock price happen due to an announcement or increase in dividend whereas a decline in dividend leads to a fallen stock price.

Shareholders feel that directors and managers of companies have better knowledge about companies' prospects. Therefore shareholders try to gather the scraps of information available from insiders to make sense of it. This is attributed to information asymmetry in the capital markets.

When it comes to signalling the information content of dividends, for example, if a firm's long-term financing prospects are bright, but it is also planning capital expenditure in the near future, therefore the need of the hour may be to carefully cut down the dividends which may send a negative signal in the market by reducing the stock price. The shareholder may think that the company earnings are likely to fall which is actually false. Hence the manager should consider the signalling effect while formulating a dividend policy.

Dividend payment

The battle of dividends followed by the firm has always been an interesting topic of research. One of the earliest works on this area was done by John Lintner in 1956. Lintner did his study with the forms of viewers to study the battle of dividends. The findings of the study are as follows. Firms set long-term target payout ratios. Managers are concerned about the change in the dividend rather than the absolute level.

They do not consider investment requirements before amending the pattern of dividend payment behaviour. Dividend payments depend on earnings and retained earnings in reserves can be used for disbursements. Dividends are sticky in nature as managers are reluctant to affect dividends changes that can be detrimental to investor confidence. Investors perceive uncertainty towards distant dividends and attach higher risk to it in times of uncertainty and look for informational content of dividends and signalling by the management. Information content of dividends means that managers signal about future prospects through dividend announcements.

“What is happening to the dividend payouts and when will they return to previous levels?” This is a question most shareholders are asking particularly since the onset of the Covid-19 pandemic. Investor assurance has changed over time, causing significant consequences for financial markets. Clear dividend policy statements help investors ascertain, strategise and target safe investment or reinvestment for optimal returns. Certain NSE-listed companies with a history of good dividend yields and payouts based on their earnings per share have cited the pandemic as a reason for low revenues and issued nil or low dividends during years 2020 and 2021, despite making noticeable profits.

The CMA should also probe the sudden and drastic decline in the share prices of certain companies. Where dividends are concerned, management of companies must always remember, for shareholders, dividend in hand is worth more than promises of the future.

Ritesh Barot is a business and financial analyst, humanitarian, conservationist, occasional artist, recipient of OGW honor. [email protected]