What is the dividend irrelevance theory
The theory of irrelevant dividends is the theory that investors do not need to worry about the dividend policy of a company because they have the ability to sell part of their equity portfolio s ‘they want money.
Understanding the theory of irrelevance of dividends
The dividend irrelevance theory indicates that a company’s declaration and payment of dividends should have little or no impact on the stock price. If this theory is true, it would mean that dividends do not add value to the stock price of a company.
Still, studies show that stocks that pay a dividend, like many blue chip stocks, often increase in price by the amount of the dividend as the book’s closing date approaches. Although the dividend cannot actually be paid until a few days after this date, given the logistics of processing such a large number of payments, the share price generally drops the dividend amount again. Buyers after this date are no longer entitled to the dividend. These practical examples may conflict with the theory of irrelevant dividends.
Analysts perform valuation exercises to determine the intrinsic value of a stock. These often incorporate factors, such as dividend payments, as well as financial performance and qualitative measures, including quality of management, economic factors and an understanding of the company’s position in the industry. .
Dividend irrelevance theory and portfolio strategies
Despite the theory of irrelevant dividends, many investors focus on dividends when managing their portfolios. For example, a current income strategy seeks to identify investments that pay above average distributions (i.e. dividends and interest payments). Although relatively reluctant to take risks, current income strategies can be included in a series of allocation decisions on a risk gradient.
Income-oriented strategies are generally suitable for investors who need stable and established entities who will pay consistently (i.e. without risk of default or without dividend payment due). These investors may be older and / or willing to take less risk. Dividends can also be included in a range of other portfolio strategies, such as capital preservation.
Blue chip companies generally pay stable dividends. These are multinational companies that have been active for several years, including Coca-Cola, Disney, PepsiCo, Walmart, IBM and McDonald’s. These companies are dominant leaders in their respective sectors. and have built highly reputable brands, surviving multiple economic downturns.