Corporate Finance
Vodafone is a telecommunications company that was chosen because they are also one of the leading providers in the US. They are operating in the technological sector that is almost immune to the recession, but very sensitive to any changes in the telecommunications technology. This company is selected to showcase the difference in strategy that it will have as compared to the financial sector represented by HSBC.
GlaxoSmithKline which belongs to the pharmaceutical industry was chosen because it is also a leader in its industry and is representing the health industry. Although the companys drug products are dependent on technology, the factors and the interacting elements that influence this kind of companies is entirely different from Vodafone. GlaxoSmithKline represents the health needs of the world population today.
In relation to the efficient market policy, the dividend policy and stock returns are supposed to reflect the knowledge and expectations of the investors at any given time. This theory is very naive in assuming the reactions of investors will be reflecting all the information available for the market. First of all, there exists a certain inequality between the investors themselves. There are a lot of first time investors. They are financially unskilled that is why they are not able to tell whether or not they should be buying or selling their shares of stocks. This makes it a strong case to render the efficient market theory invalid.
The interpretation alone will never be the same with everyone. The reactions are not necessarily intelligent decisions. The basic premise of the theory is also flawed, since it assumes that one cannot beat the market. Since the market shows the reaction of everyone dealing with it, it does not mean that you have to follow the trend that everyone else is following. The most important evidence of this would be Warren Buffet who happens to be the best investor of all times. He has already been beating the market average consistently for the past few decades, (Gujarati 1995).
The dividend policy clearly does not reflect the ideas proposed by the efficient market theory. The increase in dividend does not necessarily mean a better performance of the company or a positive outlook of the investors for the company. Similarly, a lower dividend policy does not mean a bad or poor performance of the company. It does not mean the company is in dire straits just because of the lower dividend policy.
The statistical technique used in order to determine the relationship between the dividend and the share prices is the scatter graph analysis. This technique is chosen specifically because there is a difference in the units of measurement of the two variables. We are only after the relationship that we can derive from these two. The two variables we are comparing are the share price and the dividend of a company. They are very different in terms of category. The connection between the two however can be determined to some extent with the use of a scatter graph to determine their correlation.
The x and y axis of the graph will show whether the two different values correspond to any changes in the other one. The data gathered will be close to each other and form a recognizable line. The line may or may not be in proportion to the values of the x axis. There is correlation however between the two values as long as the distance between the data is not too far away from each other. The correlation factor used to determine the extent of the connection between the two variables is near 1. If the correlation factor is lower than 1, it would mean lesser correlation between the two variables. We can determine the connection of the two variables depending on the correlation factor that we determine. In this case, we have seen the scatter graphs showing little correlation between dividend and share prices. The conclusion we can derive from this data can only mean that there is no connection indeed between share prices and dividend yield (Field 2005).
On the other hand, the companies have different policies when it comes to their dividend since they are also encountering different situations. The three sample companies in this case are showing the differences between their business environments in terms of their dividend policies. They are specifically chosen to illustrate the relationship of the dividend yield with the share price. They cover different industries to point out the interaction of macroeconomic factors with the financial condition of any given company.
First, HSBC has been negatively impacted by the worldwide stigma associated with the financial industry but was fortunate to recover with the market after a few months. There are still many issues that HSBC needs to deal with. They are out of the danger zone for now. There have not been any drastic changes in the dividend policy of HSBC despite the ongoing financial crisis. The dividend has actually remained the same from previous years even though the earnings have already dropped considerably.
As for Vodafone, they need to invest much in their infrastructure. The fast development of the telecommunications technology requires this firm to stay abreast of the latest development in their field. The reduction in dividend clearly indicates that the company is planning some heavy spending. They are most likely planning to invest in new technology infrastructure to improve their current operations capability. The reinvestment of Vodafone into their own business would mean bigger returns in the future as well as increased competitiveness in their respective field. Vodafone has an erratic dividend policy within the last five years. It started low on 2005 and then swings upward and comes back low again on 2008. The financial crisis however has surprisingly increased the earnings per share of the company. Vodafone is able to increase their dividend payments to shareholders as well.
GlaxoSmithKline on the other hand greatly reduced their capacity for the dividend payments of their shareholder. Their sector is also greatly hit by the financial crisis but the demand for their products and services are not slowing down. The decision of the company to issue huge dividends shows they might be trying to use it to increase their competitive advantage. Thus, they can invest more into the research to create new drugs. This can ensure the future profitability of the company for a very long time. If they are not going to invest in the research, they will have no new products to offer in future. Pharmaceutical findings are always changing as well as the medical profession. GlaxoSmithKline has to invest in the development of new drugs otherwise they will face obsolescence and cease to exist as a business entity.
GlaxoSmithKline did not feel any significant decline despite the economic crisis. The nature of their products is considered essential. It would always be in demand despite people having lost their regular means of income. Their products are literally saving the lives of the patients. This is the reason why their products are enjoying inelastic demand. Their company actually posted higher earnings compared to the years that the financial crisis was just building up.
The selection of these three companies is based on the fact that they are all operating in different industries or economic sectors (Revsine 2004). The relationship between their share prices as well as the dividends paid to the shareholders is analyzed for the connection between the dividend policy and the resulting share prices.
Graphs show that there is no relationship between the share prices of the company and their dividend policy. The dividend policy simply indicates the relative strength or weakness of a company and not exactly the fundamental truth behind the scenes. Using the null hypothesis testing, the null hypothesis would be whether the increase in share prices would correspond to increase in dividend yield as well. The received data were all less than the 0.5 confidence factor (Field 2005). The hypothesis therefore is false. There is no connection between share prices and dividend yield. This can be easily explained by the fact that the companies with high earnings do not necessarily give out dividends to their shareholders.
All of these data are confirmed by the ideas taught by Banjamin Graham, who is considered an expert on the subject. Bejamin Graham points out that the share prices of a companys stock are mere fluctuations of the markets opinion at that moment. The perception of the market always changes in time. The investor does not have to share the sentiment of the market at any given time. The market is actually affected by the greed or fear of the investors. If the investors are feeling greedy, they drive the share prices of the stocks by engaging in a buying spree. If the investors are feeling fearful, they drive the stock prices even lower by selling them all at the same time (Dodd 2009).
Sensible people place more emphasis on the better standards when deciding the moment to buy a stock. The price quotation given by the market should not be perceived as an authority in the actual value of a stock. The term intrinsic value is used by Benjamin Graham to separate the business value of the company with what the rest of the market thinks of it. He proposes that the prudent investor should determine the intrinsic value of a stock to determine whether it is expensive or cheap compared to the market price offered. If the market price is cheap, he suggests that the investor buys the stock. On the reverse, he cautions the investor to shun the stock if it is too expensive relative to the intrinsic value. In determining the intrinsic value of a stock, he suggests that the investor study the financial statements of a company.
The investor should be able to determine to some extent the past performance of the companys management as well as the possible future profitability. The potential threats and opportunity surrounding the business should also be taken into consideration. The intrinsic value is then determined by calculating the potential future cash flow of the business using the net present value method. This is done in combination with a qualitative analysis that will cover potential threats to make the business model of the company obsolete. This is especially the case with technology based companies whose method of earning depends on a certain product. If the technology is made redundant, their product will also face obsolescence in the market. This is one of the major considerations done together with the calculation of the net present value to determine the safe return to an investors capital. The qualitative as well as quantitative information has to be combined to create a complete picture of the stock being considered for investment.
The management of the company might decide they need money for further expansion or to prepare for intensive investments. Otherwise, a company that faces financial problems might actually pay out a higher dividend rate than their wealthier counterparts, since they have no better option. They are not in the position to invest more in their business as they lack the competitive skill to be dominant in the field. It is not a matter of who has the most resources sometimes but rather who has the most efficient and capable organization. The companies that are in financial trouble can give out dividends because they might be trying to bolster their image with the public to prop up their share prices in the market. The investor has to be very discerning when reading a companys action.
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