Question

Explain why some investors prefer getting dividends and why others prefer getting capital gain!

Answer 1

The preference of investors varies between dividends and capital gains. This occurs due to various factors such as:

1. Liquidity need

Some investors prefer to hold cash in order to meet their expenses. In such cases, dividend paid in cash would be preferable for them over capital gains.

2. Guaranteed return – dividend preferred

Dividend is an immediate pay out when company performs well, investors will receive it for sure after it is declared in annual general meeting. On the contrary, in case of capital gains, there is uncertainty as the same can be realized only at the time of sale of shares. Also it involves tax impacts.

3. Wealth maximization – capital gain preferred

Some investors prefer to maximize their wealth in the long run. According to Walter’s model, money should be invested in the place where return generated from it is more. If company is able to generate return which surpasses the expectation of investors, it is more profitable and logical to invest the company’s profits back into the company itself. This is called plough back of profits. When the company does this, it generates more return which is further re-invested and this cycle continues. At the end, company is able to maximize wealth of shareholders which is reflected in the market value of shares held by them. The same will not be possible if the company pays out its return in the form of dividend.

4. Reinvestment – dividend preferred

Investors receiving cash dividends would like to re-invest the same in shares of the same company, which thereby increases the number of shares and also the dividend earning capacity of the investor.