The value of a dividend is expressed as some percentage proportion of the number of shares held. A relatively low payout could mean that the company is retaining more earnings toward developing the firm instead of paying stockholders. Some investors would prefer this low payout because it hints at future growth. Furthermore, retained earnings lead to long-term capital gains, which have taxation advantages over high dividend payouts, according to the Taxation Preference Theory. Taxes on capital gains are deferred into the future when the stock is actually sold, as opposed to immediately like cash dividends. Furthermore, capital gains are taxed at lower rates than dividends. Therefore, taxation benefit is another point in favor of low dividend payouts .
Investor preferences for low dividend payouts
According to the clientele effect, firms offering low dividend payout will attract certain investors who are looking for a long term investment and would like to avoid taxes.
However, under dividend irrelevance theory, the actual value of a dividend is inconsequential to investors. If the dividend is too low, they can simply sell off part of their portfolio to generate more income for themselves. The conflicting theories on dividend policy complicate interpretations of low dividends in real life.
Dividend value must also be considered in relation to other measures of the firm, such as their earnings and stock price.
If a stock has a low dividend yield, this implies that the stock's market price is considerably higher than the dividend payments a shareholder gets from owning the stock. There are a number of ways to interpret this ratio. A history of low or falling yields may indicate that the firm's cash situation is not stable. They cannot afford to give higher dividends because they do lack cash on hand.
This instability can be seen in calculating the dividend cover, which is calculated as DC = EPS/DPS. A ratio of 2 or higher is considered safe—in the sense that the company can well afford the dividend—but anything below 1.5 is risky. If the ratio is under 1, the company is using its retained earnings from a previous year to pay this year's dividend, which signals the risk of instability and poor performance of the firm. Signs of risk will deter investors, particularly if they are looking for cash dividends as a steady source of income.
Conversely, a low dividend yield can be considered evidence that the firm is experiencing rapid growth or that future dividends might be higher. Investors who prefer a "growth investment" strategy may prefer a stock with low to no dividend yields, as that is one of several indicators for a firm experiencing quick growth.