Firm Valuation

How do stock prices and dividends reflect the value of the firm?

Introduction

The study conducted by David power and Ian March for the theoretical relationship between the dividend and prices of stocks. The result of this study was based on U.K. companies which indicated that the stock prices and dividends are co-integrated. This paper will discuss the how does stock prices and dividends reflect the value of the firm.

Thesis statement

Value of the firms is determined through the underlying cash flows.

Discussion

The profit generated by company has to be either distributed to the shareholders of the company or this money can be reinvested for future profits in operation or profitable investment or will utilize to payoff their debt. When company makes an announcement regarding dividends to the shareholders, usually the prices of the stock next day will increase. Dividend are the return that shareholder s received due to their investment in the company. The portion of the company's profit is given on the bases of the shares they owned. Dividend and it polices has an important place in the shareholders mind. In this competitive and tough financial era, investors look for those shares that usually pay monthly income (dividend) in order to meet their requirements (Bougatef K., 2011).

Dividends are the only ways to understand a company and without dividend, equity investment would be no more than taking risk. But dividend has very little relationship with the company's actual value, otherwise signaling mechanism to attract more investors. Hence, the company's value is determined through the underlying operation which permits company to pay dividends to the shareholders in the first place. Generation of more cash what is required by the company to finance it operating plan, ought a company to make dividend payments.

For instances, companies such as Google which has attractive growth opportunities and had never paid dividend to the shareholders neither it is expected to pay and still their stock prices are rising. Dividends are irrelevant to determine the value of firm. For companies which are mature and are in their late life cycle, dividend by these companies is to make sure that management does not waste money on unfeasible projects (Hashemijoo M., Ardekani, A., Younesi, N., 2012).

Addition to this, mature companies establish a considerably communicated dividend program in order to pulls investor base. This pressurizes companies to preserve and increase dividend from time to time to satisfy investors. The reductions in dividends are the last resort which is available with the company. The market perceives that the company cannot meet it underlying operation due to which they have reduced these payments and ultimately the price of the company stock drop. The cause of fall in stock price when company decreased the dividend is not due to the smaller dividend payment, rather, the stock price fall due to the interpretation of the market that reduction in the dividend is the signal that the company's underlying operations now are weaker compared to previous anticipation. This will further reduce the cash ...