Day 133 The dividend and the share price

The dividend and the share price

The dividend is probably one of the most important features on company shares. It provides a series of future cash flows for the investors based on the company’s annual performance. Since the measure of the stock value can be really complicated, the dividend valuation method provides investors a general intrinsic assessment of the share. And consequently, we should consider the impact of every dividend announcement from the corporation.

As we know, the dividend would be partially paid through the company’s net profit. Therefore, before we proceed with the stock valuation by dividend, we have to comprehend the three major indicators that are commonly used to determine the company’s performance. At first, the Earnings Per Share(EPS) is the net profit less preference share dividend, divided by the number of ordinary shares. It indicates the proportion of profit allocated to each ordinary share. Although the entity would normally retain a large amount of profit, we can still treat this EPS as the profitability figure on the share. In addition, investors divide the market price per share by the EPS to calculate the Price to Earnings ratio(PE). This ratio is the critical measurement of the return on our investment, so if this amount is too high, investors must be aware of the possible bubbles on overestimated share price. Furthermore, the dividend yield can be computed using the annual dividend received divided by the market price. This instrument represents the percentage of return we expect to earn in regard to the current investment cost. Through study these three ratios, we get the basic idea of the effect on dividend, and in some cases, the dividend will be reinvested into shares thus we will obtain more profit returns due to the compound returns.

Despite other market or exogenous factors that affect the share price, investors may use the dividend valuation model to presume the share value. However, the different anticipation of the dividend growth rate varies the calculation formula into three distinct approaches. The easiest way is to assume the dividend payment will remain constant, thereby we may implement the formula of an infinite consistent return, which is the fixed dividend divided by the nominal interest rate. On the other hand, we can also estimate the dividend will remain a constant growth rate, as a result, the present value of the investment should be the expected return from next year divided by the nominal interest rate subtract the growth rate. At last, investors will face the challenge of various growth rates on dividends in actual application, hence the combined method should be introduced.

In conclusion, the dividend might be an important factor on stock evaluation, but we need to acknowledge it provides limited information. In modern stock market, other factors play the more crucial role since the dividend is simply not the investor's main goal.