Dividend Policy in 19 min: Cash Dividends for Dividend Payout Ratio
Hello and welcome back again to MBAbullshit.com.
The topic for this video is Dividend Policy and Dividend Payout with regard to Cash Dividends.
Remember you can always go back to MBAbullshit.com.
Please note this video shows an example where the company uses cash to pay dividends to
the owners or shareholders or stockholders.
There are also other ways a company base dividends its shareholders such as by giving free new
shares of stock to its shareholders or by the company simply buying back its own shares
in the general stock market and this slightly more complicated but it’s still easy.
I explained that in my other videos at MBAbullshit.com, Dividend Policy and Dividend Payout Stock
Repurchase and Dividend Policy regarding Stock Splits or Stock Dividends.
Please don’t be confused about these different ways of giving dividends to your stockholders.
So regarding cash dividends, let’s start with a cash question.
Why would you want to own part of a company?
Well, because the company can earn more money but so what?
Who cares if your company earns money?
Well it’s the company which earns money and it’s not you, right?
Why would you want the company to earn money?
Because in theory, after a company earns profits or money, it pays all of that money to you,
in theory of course in real life they don’t pay the whole thing.
They keep some of the money for themselves, in the company, so that they can use it for
expansions and stuff like that.
But in theory, after a company earns profits and money, it pays that money to owners like
you in the form of dividends.
It’s called dividends.
It’s just a name.
Dividend is just name for money that the company pays to you with their profits because you’re
one of the owners of the company.
It’s your share of their profits.
That’s good, right?
It sounds great.
You own part of the company, he earns money or earns profit, and it shares the profit
with the owners such as you.
But in real life, some companies are stingy.
They keep one hundred percent of the money or the profits inside the company and they
pay zero percent of the money to owners and shareholders or stockholders like you.
That’s horrible, right?
It sounds horrible.
However, other companies are generous.
They might pay you one hundred percent of their profits to owners and shareholders and
stockholders like you and keep only zero percent in the company.
That’s great, right?
The first case, it’s horrible; in the second case, it’s great or so you think but let’s
see if that’s really true.
Which company would you like to invest in and buy shares in: the stingy company or the
generous company?
Well of course, you’d like to buy shares into the generous company because whenever
there’s a profit, they give it to owners such as you.
Question is: are you sure if you would want to put your money in the generous company?
Let’s take a look at this case right now.
On Monday, I need to put some days of the week so that you can see what happens in time
because different times you see different things, you’ll see in a while.
So on Monday, Mr. BOB owns ABC Company which has one hundred dollar cash and two hundred
dollars worth of equipment.
The company’s worth has a total of three hundred dollars.
That’s Bob over there.
Let’s see.
Monday, he owns his company which has one hundred cash and two
hundred dollars worth of equipment.
So on Monday, Bob has zero cash for himself in his own pocket, in Bob’s pocket; not
in the company.
This one hundred dollars cash is in the vault of the company.
It is not in Bob’s pocket.
On Monday, Bob has zero dollars cash in his own pocket but he owns a company worth three
hundred dollars.
Why is the company worth three hundred dollars?
Because it has one hundred dollars of cash and the company also has two hundred dollars
in equipment.
So that’s why it’s three hundred dollars.
What is Bob’s total wealth on Monday?
It is three hundred dollars.
Even if Bob has no cash, he owns a company worth three hundred dollars.
Remember ABC Company has one hundred dollars cash.
It’s full.
On Tuesday, ABC pays its one hundred dollars cash to its owner Bob.
Now the company has zero cash but it still has two hundred dollars of equipment.
How much is the company worth now?
Well, it’s now worth only two hundred dollars down from three hundred dollars because it
had two hundred dollars worth of equipment plus one hundred dollars cash.
Now, the company only has two hundred dollars in equipment.
Now the company’s total worth is two hundred dollars.
What happens on Tuesday?
Bob now owns one hundred dollars cash.
Where did Bob get this one hundred dollars cash?
Well, because the company, ABC, paid one hundred dollars cash to Bob.
So now Bob has one hundred dollars cash inside his pocket but his company, Bob’s company,
is now worth only two hundred dollars.
Why?
Because the company which was worth three hundred dollars is now worth only two hundred
dollars because the company already gave up, gave away its one hundred dollars cash to
Bob.
What is Bob’s new total wealth?
It is still three hundred dollars.
You see?
By the way, before anything else, this assumes that the shares of stock are easily converted
to cash like it can be sold in the stock market.
In this case, the company is worth two hundred dollars if Bob wants to have two hundred dollars
instead of the company, Bob can easily go to the stock market and convert or change
his company to cash in the stock market.
Anyway, the point is even if the company’s generous and paid its dividends, it still
doesn’t help Bob in the end.
His worth, his net worth changed from three hundred dollars to still three hundred dollars
even if the company paid him a cash dividend of one hundred because when the company paid
him a cash dividend of one hundred, the company’s own value went down from three hundred to
two hundred, and so now Bob’s holdings in the company are now of lower value.
The conclusion is: it doesn’t matter whether a company pays cash dividends to its shareholders
or not because it won’t affect the total wealth of the owners or shareholders or stockholders
and that is if you believe this theory.
There are different theories in finance and I’m discussing all of them one by one which
are taken up in business school so that’s depending on the theory that your professor
wants or you can answer it, and this is not only for business students.
If you might be a stock investor and think that it’s better to invest in a company
which pays higher dividends, you may be correct in real life but it’s almost good to think
about this theory as well.
Let’s go to the real world now.
In the real world, some investors actually do prefer high-dividend stocks and yet other
people prefer low-dividend stocks.
Why is that?
debbierojonan Page 1