http://www.investopedia.com/articles/fundamental/03/102903.asp
One of the simplest ways for companies to communicate financial well-being and shareholder value is to say "the dividend check is in the mail."
1. The profits of the company can be used to payout dividends or to be reinvested into the company as retained earnings.
2. Relationship growth and dividends.
Microsoft initially did not pay any dividends, it reused all the profits to expand its business. After a while, it turned a mature business; it could not provide the same unprecedented growth as earlier . Hence, it started paying out dividends as capital appreciation so that investors could find better investment opportunities elsewhere.
3. Indicators:
a. Dividend yield: annual dividend paid/ current market price.
If a company has a low dividend yield compared to other companies in its sector, it can mean two things:
(1) the share price is high because the market reckons the company has impressive prospects and isn't overly worried about the company's dividend payments, or
(2) the company is in trouble and cannot afford to pay reasonable dividends.
Dividend yield is of little importance for growth companies because, retained earnings will be reinvested in expansion opportunities and give more capital gains to shareholders.
b. Dividend Coverage ratio: company's earnings/net dividend paid to shareholders..ie..EPS/DPS...
Value:
1)>=5 :The company might be holding too much of the earnings.
2)2 or 3: Feel safe.
3) <1.5 : Risky
4) <1 : Reinvesting
3) Other salient points:
a)While a history of steady or increasing dividends is certainly reassuring, investors need to be wary of companies that rely on borrowings to finance those payments. Again, take the utilities industry, which once attracted investors with reliable earnings and fat dividends. As some of those companies were diverting cash into expansion opportunities while trying to maintain dividend levels, they had to take on greater debt levels. Watch out for companies with debt-to-equity ratios greater than 60%. Higher debt levels often lead to pressure from Wall Street as well as debt-rating agencies. That, in turn, can hamper a company's ability to pay its dividend.
b)Dividends bring more discipline to management's investment decision-making. Holding onto profits might lead to excessive executive compensation, sloppy management, and unproductive use of assets. Jarad Harford, professor of finance at University of Oregon, finds that the more cash a company keeps, the more likely it will overpay for acquisitions and, in turn, damage shareholder value. In fact, companies that pay dividends tend to be more efficient in their use of capital than similar companies that do not pay dividends
2)
