2 Factors to keep in mind when looking at dividends!


The following are the two factors that impact the dividend of a company:

Cash Dividends

Cash dividends come from retained earnings, the accumulated profits of a company. Therefore, the balance in the retained earnings account limits the amount of cash available for dividends. Creditors may impose additional restrictions on retained earnings that reduce the amount available for dividends. Unlike interest, dividends are not tax-deductible — a company generally pays them with after-tax money. A company must pay any preferred stock dividends before shelling out dividends on common stock. If the preferred stock is cumulative, the board must pay any missed preferred dividends before resuming common stock payouts. The board can initiate, omit, increase, cut or simply not pay dividends as it sees fit. A related example in the domain comes through TABCORP Holdings (ASX: TAH), which has priced a $US1.4 billion ($1.8 billion) issue of long-term notes to investors in the US private placement market. The notes have been said to comprise four U.S. – dollar- denominated tranches, totaling $US1.25 billion and two Australian-dollar-denominated tranches, totaling $195 million. The proceeds from the issue will be used to repay $1.8 billion bridge financing facility in connection with the merger with Tatts Group and to repay existing bank debt, the company said in a statement to the Australian stock exchange. Lately, it announced about the cash-settled equity swap entered with Tatts Group Ltd (Tatts) through which TABCORP gets voting rights over 147 million Tatts shares at the back of an investment of $4.34 per share. This is indicative of a 10 per cent stake in Tatts. During the term of the swap, TABCORP will receive payments equivalent to cash dividends paid by Tatts for the 147 million shares.

Growth Factors

Dividends reduce the amount that a company can invest in profit-making operations. The board must decide which new or existing projects can benefit from the cash otherwise used for payouts and whether those projects would increase the company’s return on equity. It’s the board’s job to maximize shareholder wealth. If it pays dividends instead of funding potentially profitable investments, shareholders might complain that the board is not doing its job properly while they may momentarily be happy with some dividend-based income. The investments should return an amount greater than company’s weighted average cost of capital, which is how much it pays for the money it uses for investments. When investments grow the company, the stock price usually appreciates. Companies with a higher rate of growth, as reflected in their annual sales growth, a ratio of retained earnings to equity and return on net worth, start preferring high dividend payouts.


XRO Daily Chart (Source: Thomson Reuters)

For an example: Xero (ASX: XRO), which is a technology company, has delivered significant new products like Xero HQ App Suite, Xero HQ Ask and Xero Discuss. Financially, it performed well and recorded an increase of 37 per cent as operating revenue ($188 million) for 1H FY18 as compared to the same period in the prior year. The share price was up by 21.6 per cent in the past six months. Thus, such stocks believe in strengthening the roots first before delving into the dividend story.


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