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Dividend Expectations and Stock Selection

Nov 27


This article explains why increased dividend expectations are a strong bet for rising stock prices.

A dividend is a portion of a company's earnings that is dispersed to shareholders within a fiscal year. Some corporations declare growing dividends every few years, while others are new to dividends and yet others have been giving consistent dividends for a long time. What do rising dividends imply for shareholders? How does the stock market respond to the news that dividends are being increased? Can larger dividend expectations be utilized to drive investing decisions?

Importance of Dividends

Increased dividends imply more returns to shareholders. Dividends give a higher net return than interest income since they are taxed at a lower rate in most nations. They also act as a buffer against declining share prices during an economic crisis, especially if the equities are high dividend paying or defensive. Dividends are genuine cash. They reaffirm trust in the company's financial statements (net earnings can be easily manipulated by aggressive accounting policies and changing accounting choices) and confirm that cash flow from activities is positive and sufficient.

Dividends and Stock Prices

After bigger dividends are announced, the price of the company's shares rises and stays there for a long time. Consider Canadian consumer staple stores such as Saputo Inc, Loblaw Companies Ltd, and Maple Leaf Foods Inc. Saputo Inc's shares were usually trading below $15 per share prior to the start of the quarterly dividend of 5 cents per share. However, since the beginning of the quarterly dividend in August 2003 and the constant increase in dividends year after year, the company's shares have increased in value. The stock price rarely fell below $20.00 when the dividend was increased to $0.12 per share. Similarly, subsequent dividend increases and greater stock prices were found to be positively associated.

A similar positive correlation may be established with Loblaw Companies Ltd, which began paying dividends in September 2003 and increased them until March 2005. The stock price of Loblaw Companies Ltd grew from $55.72 in September 2003 to $67.77 on April 1, 2005. However, since the firm stopped increasing dividends in April 2005, the stock price has continually fallen to $29.99 on January 2, 2008, despite the fact that the entire stock market has performed well. Similarly, once dividends were instituted in September 2003, the stock price of Maple Leaf Foods Inc climbed steadily for a few quarters. However, when dividends were not increased at a later date, the stock price fell.

Dividends and Stock Selection

Clearly, the prospect of rising dividends can be used to buy equities. Also, if dividend announcements outperform analyst estimates, it may be a good moment to buy equities. Expectations of larger dividends, on the other hand, cannot be the decisive factor. If the stock price is already overvalued, a decreased economic growth rate, an economic recession, or other circumstances specific to that firm or industry could have a negative impact on the stock price.

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