Dividend or Capital Gain?

An optimal capital structure investigation has delivered an understanding towards how different companies balance their debt and equity. Now, as I want to discuss the dividend and capital gain that are much more into the weighing of equity; forget about debt.

 

This topic finally elaborated the real distribution of shareholder wealth maximisation which indeed the core of the entire module, the value generation. Many issues were communicated as the approaches to obtain the SWM- for example from M&A, risk managements and multinational tax; therefore I think actual systems that will shape those attempts should be explored as well.

There are two classifications for shareholders to acquire wealth from the company, which are through dividend and capital gain, or in the perspective from the company itself, this is how they focus on producing the money for their shareholders. A divided can be known as the payment given to the investors based on the company’s earnings that they decided not to keep, usually developed business more take advantages from this system. Capital gain in addition is a gain by which the company increased the performance and thus can give shareholders or investors gain above the level of money that they are invested in. In fact, researches showed that growing firms will tend to utilize it. From these illustrations, which one do you prefer when you became an investor in one company then?

Some, without a doubt may prefer to have capital gain compared to the dividend. I consider that this is specifically for ‘small and short term investors’ who see elements such as EPS when doing the investment. Let’s take a look at company like Research in Motion (RIM) that I showed in this following graph.

 

Share prices were likely to fluctuate yet increase if seen here, thus I can further say that it will give access to the investors to buy or buy back and sell it when appropriate time comes. Moreover EPS increases as the share price rise; immediate action and earning will be obtained by them accordingly. If for instance they buy on April 22, 2013 with price $13.99 and sell it tomorrow with each share $14.33, some increases in wealth have been achieved by the simplest way. That is why that type of investor will choose to have capital gain rather than dividend because without getting involved in the company and take consequence of long term uncertainty, they could earn some money. However they sometimes lean to huge loss when the share price plummeted.

On the contrary, increasing in share price does not reflect a higher dividend payout, however the argument says that ‘big shareholders’ who generally take part in the course of business prefer the dividend because even though level of future uncertainty is high, capital gain has even higher insecurity due to the ‘loss’ mentioned previously. At least, investment worth 0, rather than huge negative value comes out. 

In my opinion, however, as a company they should focus on different angles to let gratification are received by both types of shareholders, not only capital gain and but also the dividend payment, as there is such theory which explained that if the company does not pay dividend, investors will change over and it leads to the decreasing in share price. Financial managers should also have the ability to control every decision in the company by enhanced strategies so that they can invest in the right company, yet still able to finance and give high payment to the shareholders. What I mean here is that they need strategy to provide decent amount of dividend at first, but still do the investments opportunity that have +NPV that will cover all the costs of capital, and pay it to the shareholders higher when the cash derived. While waiting for it, they have to make assurance that performance goes well, so that share price may grow and the ‘big shareholders’ can provide theirselves with extra dividend by buying-selling-buying back some of the shares that they have.

Hence almost certainly they can provide high divided as well as capital gain like these below firms in the future and shareholders can feel worthwhile waiting for the company to become their loyalties.

Optimal Capital Structure

Debt and equity are considered to be an optimal capital structure. Its definition is commonly the techniques that firms should effectively utilize the available sources of finance to inject their capital to operate their business. There is a relation between this concept with the shareholders’ return after all; and thus one of could be considered and chosen as ‘more optimum’ as it will lower the overall cost of capital. In other words, we should have best capital structure by having right amount of equity and debt to cover the return required by the company.

As you can notice in my 3^rd blog, I had indicated that debt will be a much cheaper cost of finance that company could use rather than capital, which can make them happily reduce barrier to find a very high rate of return investments. But still, considering the risk of debt experienced by many businesses, including the one that had happened to Beazer Homes USA, Inc., is really necessary. 

The main issue today is that can you as a financial manager employ through your capital structure, on which way you weighted your cost of capital and which that will increase the project performance spread the capital by the and increase shareholder value. How can we alter our way to make the optimal capital structure in consequence?

In particular certain companies will have its own best fits because of the type of business that they are doing, but almost certainly more leverage can meant for more return. If looking at Sainsbury Plc., their strategy until recent time is by using the debt. The proofs are that the growth number of debt is higher in comparison to its equity according to its 11.89% rise in long term borrowings, while there is only 3.78% in its RE and reserves by the end of 2012. It is then the lower issue, transaction and monitoring and Sainsbury can use the tax advantages from it also, yet they should be able to control the cost financial distress risk which at this point cost of capital is started to increase again.

Additionally, Sainsbury need to be careful because shareholder value can be cut afterwards if the ‘down’ moment came, high debt will lead the company decide not to pay dividend to their shareholders and so on. The management of Sainsbury should take further concern that debt may also increase the WACC in terms of shareholder return as they need to be compensated. Undoubtedly, Sainsbury in this case could add only up to a certain point by assessing a traditional theory.