It is axiomatic that a company's current share price simply reflects the present value of all dividends paid out over the lifetime of a firm. In other words, it's all about the dividends. Investors some day need to be repaid for their capital, through dividends or a share buyback.
But it is not as simple as looking for the highest dividend payers when selecting stocks. There are several intriguing dimensions to this discussion.
For example, the Nobel Prize winners Franco Modigliani and Merton Miller argued that if a company has investments with returns greater than its cost of capital, it should cut dividends to finance such investments, which would then be reflected in higher share prices.
When Central Huijin, the holding company of many state-owned financial institutions on the mainland, announced in February that the dividend payout ratio would be cut by 5 per cent to 35 per cent of profit in 2011 at Industrial and Commercial Bank of China (ICBC), China Construction Bank and Bank of China to strengthen their capital bases, the banks' share prices rose on the view that they could now make more loans to increase profits.
If a company in need of equity continues to pay the same level of dividends, it will need to raise equity, which is a costly form of capital.
For example, ICBC conducted a rights issue in November 2010 that raised about 45 billion yuan (HK$55.1 billion), or about 2.5 per cent of its market capitalisation. The proceeds were less than the 57 billion yuan of dividends it distributed the year before.