Does the dividend policy followed by companies affect share price?

Answer 1

The dividend policy directly affects share price. There is a technique for share valuation known as the dividend growth model (DGM). The fundamental theory is that one would add up the present value of all upcoming dividends for that company, the sum of which would equate to the current stock price. The DGM assumes that a company is mature and has stable growth (e.g., inflation of 3% and relative economic growth of 3%). The DGM may be used for high growth industries; however, the growth must get to a mature rate for the results to be effective. The DGM, in reality, is really only useful as a gauge on value since there are a lot of assumptions on (1) future economic periods and (2) the ability of the company to produce cash flow during those periods. The forecasting; therefore, is crucial, and the average investor does not have/know how to use the tools available to do so. Also, there are other variables that impact stock price including the perceived value of the brand, the strength of the management team, the competitive nature of the industry, what point in the lifecycle is the company, etc. The DGM formula is as follows: Stock Price = Dividend / (Required Rate of Return - Expected Growth Rate) For example, let's say that a company has a $1 dividend that is paid once per year and is expected to continue forever. The growth rate of the economy is 3% and the expected inflation rate is 3%, making the overall growth rate 6% (in reality the value is slightly higher than 6% with compounding; however, the example is meant to be simple). The company has stated that it will only invest in projects having a 10% (or higher) return. Using the formula: Stock Price = $1 / (10% - 6%) = $1 / 4% = $25.00 Taking this policy further, let's say that the company increases the dividend to $1.20 per year and indicates that there are no other expected changes. The value, then, would change from $25.00 to: New Stock Price = $1.20 / (10% - 6%) = $1.20 / 4% = $30.00 There are versions of the formula that take into account different periods of growth and adjust the cash flows accordingly; however, at the end of the day, the ability of the company to pay dividends is highly correlated to the underlying stock price. ___________________________ Indirectly. If a company has a long history of paying increasing dividends, more people are likely to want to buy that company's stock than to sell it. Over time, this will result in the company's share price rising.