Company is doing its day-to-day commercial activities. Through this it is making profit. There are many ways to check the profitability. Gross Profit, Net Profit, Operating profit etc. What it tells is that company is making sufficient money to cover its costs and above all costs it is making wealth for the owners or shareholders.
But what if the company is only making profit which is only visible on balance sheet? Will you invest? The answer is not straightforward. We need to check what is company doing with that profit.
Some businesses are capital intensive. Like infrastructure, insurance, Aviation, Mining, Real Estate. If the company is operating in such sector, it needs to invest heady capital. If the company is startup then also it needs to keep money with it for investing in business.
But what if the company is Operating in service sector like IT? Yes they also need money but not that big. Not all segments of Service is such good but some of them are really money making.
What they are doing with the money. In fact what should they do with it? If there is good opportunity available then invest. But what if there is no big opportunity?
Giving Dividend or buyback are right choice. Even though most of the time, it is assumed as DIVIDEND Payout but it can be buyback also.
If the company is keeping this ratio constantly same or maybe increase little bit. It is good sign. If the company is holding company or investment company or asset light company then it may be show you very high Dividend Payout. ITC, Indian Company operating from tobacco to paper and hotels to IT, is showing high Dividend Payout.
There are some companies where management and shareholders are acting like children and parents. One want quick reward and one is trying to deny it. There is nothing to keep earning but what if that is the best way?
Peter Lynch, One of the best fund managers, write in his book One upon Wall Street
If a company has faith in its own future then why shouldn’t it invest in itself. Just as any shareholders do?… Exxon has been buying in shares because it’s cheaper then drilling for oil. It might cost Exxon $6 a barrel to find new oil, but if each of its shares represents $3 a barrel in oil assets, then retiring shares has the same effect as discovering $3 oil on the floor of NYSE.
Lets check if the company denied to pay the Dividend, what are other options in front of them.
- Keep the money in bank. Show big bank balance. Looks good. But why management is loosing the opportunity to make money? Are interest rates negative?
- Investment for growth. Good. But there are some exemptions for it. There are some sector which are not growing with speed. The demand is not increasing in big figure. Like oil companies. Yes they are growing but how can it will grow double in one or two year? Same with electricity companies or Cement companies or Car companies. Don’t tell me there is Tesla.
- In technology companies or some pharmaceutical there is always need to invent something new. But what about 3M, Gillette, Unilever or Nestle for that matter?
Sometimes Giving Dividend is right choice.
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