WHY MUST DIVIDEND PAYOUT JUSTIFY THE THE PURCHASE OF THE STOCK

The purchase of stock is expensive It is more expensive than the purchase of bonds The dividend that is paid from the firm to the shareholder is much less expensive than the purchase of stock Thus, if the firm cuts its dividend it will not be able to sell as many shares of its stock as it otherwise would have sold The firm may not be able to raise enough money to finance its investment plans In general, the firm will want to pay out a dividend that is large enough that the stock price is above its normal (equilibrium) price The firm will want to avoid a dividend cut For example, if the firm's stock is selling at $100 per share, the firm will want to pay a dividend of $2 50 or 3 percent This is just enough to keep the stock price above $100 If the dividend is cut to, say, $1 50, the stock price will drop, perhaps to $90 The firm will experience a stock turnover, and thus a loss of potential revenue from the sale of the stock The dividend cut will have hurt the firm The dividend payout ratio is one of the most important numbers in determining the value of the firm It has major implications for the price of the stock WHAT IS THE DIVIDEND PAYOUT RATIO AND WHY IS IT IMPORTANT? The dividend payout ratio is the ratio of the dividend to the earnings of the firm It is usually expressed as a percentage For example, if the firm's earnings are $100 and it is paying out a dividend of $2, then the dividend payout ratio is 2 percent The dividend payout ratio is important because it is a measure of the amount of earnings that will be paid to the shareholders The higher the payout ratio, the higher the dividend If a firm is paying out a high percentage of its earnings as dividends, then other investors will want to buy the firm's stock because they will know that they are receiving a high dividend