Equity investments refer to investing in stocks or shares of companies. When analyzing equity investments, investors need to evaluate aspects like earnings prospects, dividend policy, competitive advantages etc. However, there are some incorrect statements floating around regarding dividends and equity valuation.
Dividend irrelevance theory is an oversimplification
The dividend irrelevance theory states that in an efficient market, share prices will adjust such that investors are indifferent between dividends and capital gains. However, this theory makes many simplifying assumptions and does not always hold in practice.
Dividend policy does impact stock prices
The announcement of dividend changes often impacts stock prices, contradicting the irrelevance theory. Dividend policy provides signals about management’s views of earnings prospects and influences investor demand.
Dividends can reduce investment risk
Although reinvested capital gains can compound returns, dividends provide current income and reduce risk since investors do not have to sell shares to realize returns.
In summary, the dividend irrelevance theory, stating that dividend policy has no impact on share prices or investor wealth, is an oversimplification. In reality, dividends do influence stock valuations and also carry investment advantages related to signaling and risk reduction.