This paper discusses the distribution of retained earnings, the procedure for the allocation of retained earnings and the impact it has on a company and its owners. The general perception of the owners/shareholders of a company, based on the dividends paid, is discussed. This paper also presents the performance of a real-life company’s shares, to give a clear understanding of the topic.
It is sometimes believed that big businesses have ample cash and do not need to ask for money. Though the reality is quite different, companies to run out of money and need ways to finance itself.
For funding, companies use two commonly used financing techniques; debt financing and equity financing. Debt financing refers to the process of a corporation issuing bonds, bills, etc. The bonds are a written guarantee that it has to pay the money back with interest to the creditors.
Equity financing is the process in which a company issues shares on the stock markets through Initial Public Offering (IPO) and secondary IPOs. By selling shares, the company allows the shareholders fractional ownership of it, with several rights.
DISTRIBUTED RETAINED EARNING
Dividends are defined as a portion of the business’s earnings distributed among shareholders, by their status. Apparently, a company’s net profits can be distributed to shareholders in the form of the dividend, or kept by the business as retained earnings (CFA, 2003).
Retained earnings are the percentage of net earnings that are not paid out to shareholders as dividends, but are kept by the company to be reinvested (Staff, 2003). Note that retained earnings are the amount we get after distribution of dividends among shareholders, not vice versa. Hence, it is the amount left in the company’s accounts after paying expenses.
SHARE PRICE AND THE IMPACT DIVIDENDS HAVE ON IT
Its market value determines a company’s worth in the eyes of the public. A market value is the product of a total number of outstanding shares and current share price of the company’s stock. However, the market value may not be an accurate indicator of a company’s worth.
The market value depends on the share price; however, the stock price depends on some factors. One significant impact on the share price is that of dividends paid by the company. Stocks that pay dividends are consistently are popular among shareholders.
Everybody wants to buy shares that pay dividends regularly, especially those that pay a handsome amount. For example, a U.S based company; Weatherford International has paid no dividend in the past few years, and its stock price is USD 4 (“Investor Relations | Weatherford International,” n.d.). While similar company; Halliburton, that pays dividends regularly has a stock price of USD 41.
This shows that the market favors dividend paying companies and only such companies experience a surge in their share price. In fact, many investors buy a particular stock just before the company is to issue a dividend. After consuming it, they sell their shares. This action against the Dividend Irrelevance Theory, which states that investors are not interested in dividends, they buy shares so they can later sell them for a profit (Staff, 2005).
Hence, it is proved that investors buy shares that promise to bring in profits for them. And market value of a company is a good indicator to judge a business’s worth. Dividend paying stocks bring in money for long term investors, so they are high in demand, and their share price is usually more.
CFA, A. H. (2003, November 25). Dividend. Retrieved September 8, 2017, from http://www.investopedia.com/terms/d/dividend.asp
Investor Relations | Weatherford International. (n.d.). Retrieved September 8, 2017, from http://ir.weatherford.com/home?%20ga=2.230240596.997840560.1504697152-1238389106.1466421525
Staff, I. (2003, November 25). Retained Earnings. Retrieved September 8, 2017, from http://www.investopedia.com/terms/r/retainedearnings.asp
Staff, I. (2005, September 29). Dividend Irrelevance Theory. Retrieved September 8, 2017, from http://www.investopedia.com/terms/d/dividendirrelevance.asp