Payout Policy - Pay out

This post will continue on the same topic as last week. Make sure you check out that post before you keep reading! (Last weeks post: http://illuminatingfinance.blogspot.com.au/2014/04/payout-policy-retained-earnings.html). Remember that if you have any questions or comments make sure that you email them to illuminatingfinance@gmail.com.

In the last blog post we discussed the options available to managers when they retained their earnings within the firm. In this post we will talk about what the firms options are when they decide to pay out the cash flow.

Dividends are cash payment to share holders in proportion to the number of shares you own. A share repurchase or 'buy back' is the process of tender of shares for repurchase by the company. The difference between repurchasing shares or paying dividends comes down to tax. In Australia if you own shares in a company for more than a year, the Capital Gains Tax on the sale is halved, making a 'buy back' seem more attractive.

However, there are also advantages and disadvantages of a share repurchase. Firstly a 'buy back' can be used to change the firms capital structure without increasing the debt load. Secondly, it can be a good indicator that management believe the price of the shares may be too low (keep in mind these people know the company better than anyone!). They are give the decision to the investor about whether the current time is good for them in terms of tax implications, they can choose to delay their sale or take the opportunity. The disadvantage is that they are often less dependable than dividends, which is often paid annually. Also if the company misjudges the share price they may end up paying a price which is too high and end up losing capital.

As an investor, you will not get a decision in what the firm chooses to do with the profit they earn (other than selling your shares!). However, knowing the impact the decision could make, may help you understand the motive behind it.

Good luck with your investments!

As always email illuminatingfinance@gmail.com with any questions or queries you would like answered!

Disclosure

Unfortunately we are not talking about the English brothers who make electronic music. This week we are referring to the regulations relating to a timely release of information for investors. I mentioned last week that due to some regulations the efficiency in a market can be effected. Continuous disclosure is the biggest regulatory factor that would affect the efficiency. Therefore, I feel as though you should at least be aware of its existence, even if you do not know the specifics.

In Australia to comply with the ASX regulations, companies must continuously disclose all pertinent information. With a quick google search of; "ASX continuous disclosure requirements" you can find all of the specifics for what needs to be disclosed. However, I believe it is rather well summed up in this sentence.

"Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information."

If you have read the post before this on market efficiency, it should be pretty obvious that if complied with, this should dramatically increase market efficiency. There are many specifics in what a reasonable person would and wouldn't expect to effect the share price, but also where a trading holts and other situations can occur. I found this abridged version particularly useful for summing up the key points concisely.

http://www.asx.com.au/documents/about/abridged-continuous-disclosure-guide-clean-copy.pdf

As always, if you are interested in additional information either follow the link I provided or feel free to shoot me an email.

What is Market Efficiency?

Efficient Market Hypothesis is the idea that the competition among investors works to eliminate all exploitative opportunities in the market. It implies that securities will be fairly priced, given all information that is available to investors.

Real markets fall on a scale between strong form and weak form, as shown above. However, it is useful to know the characteristics of each form of efficiency of the market.

Strong-form market efficiency: This implies that all information is available to the public in news reports, financial statements, corporate press releases, or other public data sources. In this situation the market will react instantaneously to any news. This implies that technical analysis will be far more accurate and given an appropriate methodology, successful.

Weak-form market efficiency: A weak for market efficiency, implies that the price of the share doesn't reflect the actual value at all. Only a small or no information that would be pertinent to an investors decision to buy or sell has been disseminated to the public. In this situation, technical analysis will not work, the price of the asset will not move with the information, making it redundant.

Semi-Strong market efficiency: A semi-strong market efficiency is one where some of the information needed to make an informed decision has reached the investor. Within the scale this is where most stock markets would be classified. The share price would reflect most of the important information about the company. Things to consider that would keep a market in this range may not just be the dissemination of information but also the difficulty in interpretation the information. Information on new technology or complicated legal or financial may require a specific analyst to interpret.

With the rise of the internet and regulatory consequences for not disclosing important information, most markets are moving towards strong-from market efficiency. Resulting in the Efficient Market Hypothesis becoming more adapt in describing our market situation.