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

The Myth of the Earnings YieldEssay written by Sam VakninSam Vaknins Psychology, Philosophy, Economics and Foreign Affairs Web SitesA very slim minority of firms distribute dividends. This truism has revolutionary implications. In the absence of dividends, the foundation of most - if not all - of the financial theories we lend oneself in order to determine the observe of destinys, is falsified. These theories rely on a few implicit and explicit assumptions (a) That the (fundamental) value of a packet is almost correlated (or even equal to) its market (stock exchange or transaction) outlay (b) That price movements (and volatility) ar mostly 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 efficiently (old information is fully incorpo appreciated in it) Investors are supposed to discount the stream of all future income fr om the share (using one of a myriad of possible rates - all hotly disputed). Only dividends constitute meaningful income and since few companies engage in the diffusion of dividends, theoreticians were forced to deal with expected dividends rather than paid out ones. The topper gauge of expected dividends is earnings. The higher(prenominal) the earnings - the more likely and the higher the dividends. Even retained earnings can be regarded as deferred dividends. carry earnings are re-invested, the investments generate earnings and, again, the likelihood and expected surface 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 some other measures. It is as though these earnings WERE distributed and created a RETURN - in other words, an income - to the investor. The reasonableness for the perpetuation of this misnomer is that, according to all current theories of finance, i n the absence of dividends - shares are worthless. If an investor is never likely to start income from his holdings - then his holdings are worthless. Capital gains - the other form of income from shareholding - is also driven by earnings but it does not feature in financial equations. Yet, these theories and equations stand in stark blood to market realities. People do not buy shares because they expect to receive a stream of future income in the form of dividends.