If you bought a share of common stock, you would probably expect to receive dividends plus an eventually capital gain. Would the distribution between the dividend yield and the capital gains yield be influenced by the firm's decision to pay more dividends rather than to retain and reinvest more of its earnings? Explain.
The distribution between the dividend yield and the capital gains yield can indeed be influenced by a firm's decision to pay more dividends rather than retain and reinvest more of its earnings.
Here's an explanation as to how this decision can impact the distribution:
1. Dividend Yield: The dividend yield is the ratio of the dividend per share to the stock price. When a firm decides to pay more dividends, it means they are distributing a larger portion of their earnings to shareholders in the form of dividends. This increases the dividend yield, as shareholders receive more cash per share of stock they own.
2. Capital Gains Yield: The capital gains yield, on the other hand, refers to the increase in the value of the stock over time. When a firm retains and reinvests more of its earnings, it is using those funds to fuel future growth and expansion of the company. This has the potential to increase the company's profitability, leading to an increase in the stock price. Therefore, retaining and reinvesting earnings can result in a higher capital gains yield.
So, when a firm decides to pay more dividends, it reduces the amount of earnings that can be retained and reinvested. As a result, the potential for future capital gains might be lower because a smaller portion of earnings is being used to drive the growth of the company. This means that, in comparison, the dividend yield may be higher, while the capital gains yield might be lower.
It's important to note that each firm's decision to pay dividends or retain earnings will depend on various factors such as its growth prospects, market conditions, industry practices, and the preferences of its shareholders.