The Myth of the Earnings Yield :: GCSE Business Marketing Coursework

The Myth of the remuneration YieldEssay written by Sam VakninSam Vaknins Psychology, Philosophy, economics and Foreign Affairs Web SitesA very slim nonage of firms distribute dividends. This truism has revolutionary implications. In the absence of dividends, the foundation of nigh - if non alone - of the pecuniary theories we employ in order to jell the note value of shares, is falsified. These theories rely on a few implicit and expressed assumptions (a) That the (fundamental) value of a share is closely correlated (or even rival to) its market (stock exchange or transaction) price (b) That price movements (and volatility) are by and large random, though correlated to the (fundamental) value of the share (will always converge to that value in the long term) (c) That this fundamental value responds to and reflects new information expeditiously (old information is fully incorporated in it) Investors are supposed to deduction the stream of all approaching in come from the share ( use one of a non-finite of possible rates - all hotly disputed). Only dividends constitute purposeful income and since few companies engage in the distribution of dividends, theoreticians were forced to deal with pass judgment dividends rather than paid out ones. The best gauge of expected dividends is net income. The higher(prenominal) the earnings - the more likely and the higher the dividends. Even retained earnings can be regarded as deferred dividends. Retained earnings are re-invested, the investments pose earnings and, again, the likelihood and expected size of the dividends increase. Thus, earnings - though not yet distributed - were misleadingly translated to a rate of return, a yield - using the earnings yield and other measures. It is as though these earnings WERE distributed and created a RETURN - in other words, an income - to the investor. The reason for the perpetuation of this misnomer is that, according to all current theories of finance, in the absence of dividends - shares are worthless. If an investor is never likely to touch income from his holdings - then his holdings are worthless. Capital gains - the other form of income from shareholding - is also impelled by earnings but it does not feature in financial equations. Yet, these theories and equations stand in stark contrast to market realities. People do not buy shares because they expect to receive a stream of future income in the form of dividends.