Dirty Little Secret with Growth Stocks Essay

Dirty Little Secret with Growth StocksDividends are corporate profits that some companies periodically pay out to shareholders. Stockholders can enjoy much larger returns, if the corporation is profitable. A company generally declares these profits for enhancing the market price of the particular stock or share. People generally want to get dividends because according to the returns only investment will be made.

The school of thought advocating dividend relevance includes (Prof. James Walter and Myron Gordon). (According to Prof.James E.Walter’s) “1The dividend decisions are relevant and affect the value of the firm.” the key argument of Walter’s model is the relationship between the return on a firm’s investment or its internal rate of return(r) and its cost of capital or the required rate of return (k).In determining the dividend policy that will maximize the wealth of the shareholders. The firm would have an optimum dividend policy, which will be determined by the Walter’s model.

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One of his assumptions is “All earnings are either distributed as dividends or reinvested internally immediately”. The relation ship between ‘r ‘and ‘k’ is as follows1. If    R>K    the firm earns a higher rate of return on its investment than the required rate return. Then the status of the firm is ‘Growth’ and pay out ratio is ‘Zero’.2. If   R<K     the firm does not have profitable investments. The share holders would stand to gain if the firm distributes its earnings. The status of the firm is ‘Declining’ and payout ratio’100%’.

(1 It is taken from the Financial Management Theory and Practice by V.N.Gangadhar)3. If   R=K     the dividends policy will not affect the market value, shareholders will get the same return from the firm as expected by them. The status of the firm is ‘Normal’ payout ratio is ‘Not changed’.

             Another school of thought felt that dividend is irrelevant because investors are indifferent between dividends and capital gains. (“2According to M.M.Hypothesis explains that dividend policy has no effect on share price and is therefore, of no consequence”). The crux of the M.

M.Hypothesis is the arbitrage process or the switching and balancing operation. It also regresses to the simultaneous movement of two transactions which exactly offset each other. The two transactions involved are paying dividends and raising capital through external funds either through the sale of new shares or raising additional funds through loans to finance investment programmers.In this session of stocks the Companies did not declare dividends to the share or stock holders they usually put there profits for maximizing the wealth.Let us see about ‘Growth stock:A growth stock usually does not pay a dividend, as the company would prefer to reinvest retained earnings in capital projects. Most technology companies are growth stocks.

Note that a growth company’s stock is not always classified as growth stock. In fact, a growth company’s stock is often overvalued.For investors, young growth stock can trigger dreams of wealth – and nightmares of poverty. These companies are often early-stage ventures that offer rapid revenue growth, but have yet to deliver earnings growth or much of a business track record. As such, the(2 It is taken from the Book of Financial Institutions and Market Structure Growth and Innovation)Potential returns can be enormous, but investing in these stocks can also be risky. There are several points investors should consider when analyzing early-stage growth stocks.

in this scheme the growth rate of wealth will be distributed by means of bonus shares.  While preparing balance sheet of the company after the issue of bonus shares, the number of shares and the source of the issue must be disclosed in the balance sheet.Again when we see about the dividends are corporate profits that some companies periodically pay out to shareholders. Stockholders can enjoy much larger returns, if the corporation is profitable the final way for a corporation to pay for new investments is by reinvesting some of the profits it has earned. After paying taxes, profits are either paid out to stockholders as dividends or held as retained earnings to use in running and expanding the business.

Those retained earnings come from the profits that belong to the stockholders, so reinvesting some of those profits increases the value of what the stockholders own and have risked in the business, which is known as “stockholders’ equity”. On the other hand, if the corporation incurs losses, the value of what the stockholders own in the business goes down, so stockholders’ equity decreases.Corporations issue stock in order to finance their business activities. This method of raising funds is only available to business firms organized as corporations; it is not available to sole proprietorships and partnerships. The corporation can use the proceeds of a stock offering in a variety of ways. Depending on the type of company, this might involve increasing research and development operations, purchasing new equipment, opening new facilities or improving old ones, or hiring new employees.

Corporations declared extra dividends but in most cases they preferred to increase reserves as a protection against the necessity of conversion to peacetime production.                      Let us consider the investment scheme in these two different modes.By taking an example of the two firms which earns an equal % of profits in all senses. Let us take the two firms are ‘X” and ‘Y’. Who started initially with an amount of $1000000. Mr. John who invested in ‘X’ company and Mr. Josef who invested in ‘Y’ they investment is $ 500000 of each individually.

years% profitDividendStock(John)Growth stocks(Josef)Difference112%6000060000nil210%5000056000600038%4000049280928045%25000332648264510%5000069854.419854.4610%5000076839.8426839.84720%100000169047.6569047.



251512%60000184221.18124221.18From the above we can conclude that in the fifteenth year in growth dividend policy it earns merely 3 times more than the profit gained because the declared dividend is put in the business for wealth maximization.

For every company or form the main aim is to earn more and more profits.In the above assumption we ignore the risk factor. Investment decision is depend upon the return and as well as risk.

   It depends on the Investors mode.In the above said assumption the profits are retained in the business for improving the business activities. By taking a little risk we can maximize the wealth in the growth option stocks.

It not only increases the profits and also increases the wealth of the investor and the business organization.In the above said example the growth rate is increased gradually three times with related to wealth of the investment. It is depend up on the sales growth, profitability of the retain earnings of the business organization.Bibliography1.

Book, author: “Book of Company Accounts Theory and Practice” by                                    M.C.Shukla, T.S.Grewal& S.

C.Guptha2. Book author: “Financial Management Theory And Practice”by                               Prof. V.Gangadhar in Kaktaiya University.3.

Book author: “Financial Institutions And Markets Structure, Growth And                             Innovations”    Prof. L.M.Bhole, Department of Humanities and Social                             Sciences Indian Institute of Technology, Bombay4. Reviews:   “The Economic Times” daily news paper related to the business                        “Business Line” daily news paper Related to the business news.5 Magazine:  “Harvard Business Review” Monthly Magazine6.

Related web sites: <http://www.Investopedia.com>                                     <http://www.joefrocks.com> 


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