Dividends And Returns On Equity

The following chart shows the returns on average equity for two companies over a decade. Returns on Average Equity Each company begins in the same spot, yet one begins an inexorable decline while the other maintains enviable performance. High and sustainable returns on equity are desirable and are one indicator of a business with a competitive advantage, so most investors would prefer to invest in Company A. Now what if I told you that this is the same company, but with two different dividend policies? In Scenario A the company paid out nearly all of its net income each year, while in Scenario B it retained this as cash earning 4% pre-tax. Would this affect your desire for Company A over Company B? On the one hand, by retaining cash at a very low reinvestment rate Company B’s returns declined dramatically and deprived shareholders of the opportunity to put that... Read more