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“If the share is trading with a low dividend yield, this means that investors have positive growth expectations after taking account of the level of risk”
I don not understand why this statement is true, I thought it would have been that investors do not expect positive growth. Please explain. Thanks.
Dividend yield is the latest dividend/share price.
However share prices are based on future expected dividends. The more growth that investors expect in the future, the more they will pay for the share.
The more they pay for the share, the higher the market value, and therefore the lower the dividend yield.
Hope that makes sense 🙂
Thanks for the quick response john.
Ok, so the higher the expectation, then the higher the market price of the share….an increase in the denominator gives a smaller fraction.
But…
What if the market value remains the same and the company decides to pay a smaller dividend for some reason…..then wouldn’t that be the opposite of what you described above? (Even though the dividend yield formula gives a smaller fraction)The share price always depends on future expectations.
So if the company paid a low dividend and shareholders expected it to be low in the future, then the share price would fall (not stay the same).
For the share price to stay the same, it would mean that shareholders were expecting high growth in the future.OK, so if both dividend and share price decrease but the dividend decreases by a larger amount then the fraction would now be smaller.in your last post u said this means shareholders would not expect growth in the future. A smaller fraction means a low dividend yield but in this case even though its small it doesn’t mean that shareholders expect growth. Do u understand why I am confused? My first post on this topic stated otherwise.
I understand what you said about the fraction becoming smaller by the share price (denominator) increasing but the fraction can also become smaller if the numerator (dividend) decreases by a larger amount than the denominator. In such a case those decreases do not mean shareholders expect growth…..correct?Yes, you are correct.
I should have faulted the original quote – what they should have said is that “a low dividend yield suggests (and only suggests) that shareholders are expecting higher future growth”
A ‘low dividend yield’ means lower than other similar companies. Also, ‘higher future growth’ means higher than similar companies. The quote should not simply say positive growth.
I should have made that clear at the start – the quote is not correct as it stands (even though I know (and I think you know) what they are trying to say).
I hope that make sense now 🙂
It does now. Thanks john for taking the time to explain, its much appreciated.
Lower dividend means less immediate cash fo shareholders and this is compensated by the fact that extra investment by the company will increase the value of the company thus increase in share value
Lowering dividends means the company now has more source of finance from retained earnings which is the best source of finance taking into account issue costs and also cash is immediately availableRuben:
Thank you for that, except that it is not answering what nari was asking.
Lower dividends now, may well mean higher growth in the future (but not necessarily). But what matters is the shareholders expectations of growth.
Retained earnings are certainly the quickest and cheapest source of finance. However they are not necessarily the best source of finance. (Debt finance can be attractive because of tax relief which is not available with equity finance; Also, using retained earnings can give rise to an adverse signalling effect or adverse clientele effect.)
(This is the Ask the ACCA Tutor Forum, so although please do ask questions here, I would ask you not to give answers – you are not the tutor 🙂 Please restrict your answers to the normal F9 Forum.)
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