Businesses that pay dividends should be applauded

May 20, 2016

While 2015 appeared to be a generally tough year for business, many of them have put out impressive results

By Charles Nsamba

Several financial institutions recently released their previous year's financial statements as required by law.

While 2015 appeared to be a generally tough year for business, many of them have put out impressive results - an indicator of their capacity to absorb shock and continue to deliver their promise.

Obviously, this is also the time for investors to ask questions; why this, why not the other, all in relation to what they ideally expect. Businesses fundamentally exist to create value for shareholders; so it is imperative that they make profits. This, however, does not mean that they will always make profits.

But when they do, profits could be used for expansion, or paid out to shareholders in form of dividends so that future expansion is either financed using bank debt or through a rights issue, which is a call to existing investors to buy more shares if they so wish.

Businesses or companies are set up by individuals who either use family or personal savings or even debt acquired from lending institutions to establish, maintain and run their operations. These individuals (entrepreneurs) establish enterprises for different motives including creating employment, creating an income stream and/or wealth for themselves and their families or giving back to their communities. But for whatever reason the business is formed, growth is imperative if the business is to survive through generations. Business growth may be attained through merging with, or acquiring another firm.

It is essential that good corporate governance structures and practices are in place as a company grows. Financing expansion may take different forms, including obtaining debt from commercial banks or other lending institutions, issuing corporate debt instruments such as bonds or commercial paper, or selling shares to increase the company's capitalization. For businesses that have opted to finance expansion through selling equity or shares, it is expected that such businesses share their profits with their shareholders. This portion of the total profits that shareholders are entitled to is what is referred to as a dividend.

While shareholders lookout for dividend payments, usually on an annual basis, some companies have opted to pay dividends twice a year, and this is dependent on their profitability and the direction that the company is taking as guided by the directors. This is why a dividend will only be paid out if the directors declare it.

In some companies, particularly those listed on the stock exchange like Stanbic Bank or Umeme, the directors may take a decision not to pay out a cash dividend, or not to pay out any dividend at all. However, in the case where they don't pay out cash dividends, companies may opt to pay a dividend in form of extra shares for every specified number of shares already owned.

For example, if you own 100 shares in company X, the directors may award 5 shares for every 10 shares held. This means that you will end up with a total of 150 shares (100 existing plus 50 new shares). This action is technically referred to as a bonus issue, and once executed may have an effect on the share price of the company.

Generally, regular dividends are paid out by financially strong and mature companies and regular dividend payment is a sign of the business' strength. Dividend payments also attract new investors into a company because they are assured of a regular income on their investment.

However, dividends aren't the only reason to hold stock. Sometimes it makes sense for an up and coming company to invest all of its profits back into the business. Growing companies especially in industries such as technology, mining and investments, which require a lot of cash to fund growth, tend not to pay out dividends regularly, even when they may be making profits. This decision to retain profits in reserves could be for an impending investment in capacity expansion or other reasons as may be given by the directors.

So in a nutshell, equity is essentially a permanent loan only payable through dividends. And if companies are not paying out dividends, impatient shareholder may elect to exit for other investments.

The writer is the communication and PR manager of the Capital Markets Authority

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