Even though, shareholders are owners of the company, but it is not the shareholder who are looking into day-to-day operations. It is the management. Shareholders may appoint Director for checking weather the management is doing it’s duty or not.
There are some decisions which are important for the Future of the Company. In short-term as well as long-term. Making Profit is one but EFFECTIVE utilisation of the Profit is another decision which holds power to ruin the Party.
What to do with earning is largely decided as per the life of company, the sector in which it is operating, Future growth etc.
There are 3 ways how management may utilise the earning.
- Reinvestment of earnings in company or Buyback. As per Peter Lynch, Buyback is same as reinvestment. Very Good decision for Many technology, E-Commerce companies and Start-ups. It will reduce the need for Debt and that Give the company less leverage.
- Buying another company. May reduce the compitition or Just reduce the Cost if the target company is supplier. Called backword integration. But if the decision is taking at wrong Time or the amount paid for Assets then the Goodwill may look heavy on Balance Sheet. If the acquisition is hostiles then Acquirer may not receive any information about out of Balance Sheet assets.
- Giving Dividend.
As per Warren Buffett, only one option is Rational. That is third.
There are many reasons why he thinks like that. But the most important is may be it gives the proof that management is not cooking the Balance Sheet and that the growth is REAL and Tangible.
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