I started working in the Bangladesh capital market from 2008 and in the course of the last 14 years analyzed listed stocks in a number of countries.
Ever since that time I found a fundamental misunderstanding of dividends among stakeholders in Bangladesh.
Dividends refer to the distribution of company accumulated profits to its shareholders.
They are an essential part of modern economies and capital markets and thus these misconceptions need to be addressed.
Stock dividend is not a dividend
The concept of stock dividend is present in very few countries of the world including Bangladesh.
That is because in its true essence it is not a dividend at all but rather a split.
However, as we call it a dividend, many investors fall in the trap of considering it as a dividend.
To understand this claim we need to look at a company's balance sheet.
In the case of a stock dividend there is literally no change in a company's balance sheet before and after the shares are issued.
Assets, liabilities and equity are virtually unchanged. There is also no cash transfer to the shareholders.
Once we acknowledge that stock dividends are not dividends at all and are almost the same as "no dividend" we can get rid of the noise and judge a company purely on its capital allocation skills.
I will discuss this further below in the capital allocation segment.
Compare this to the cash dividend scenario. After giving dividends, cash goes down by 200 on the asset side and retained earnings comes down by 200 on the equity side.
This 200 goes to the individual shareholders.
The other thing that is clear immediately after looking at both the examples above is that cash dividends are simply a transfer of money from one hand to another.
A lot of investors in Bangladesh somehow feel that a dividend is an extra return which is untrue.
Theoretically, stock price will get adjusted by the dividend amount when it starts trading after the record date.
Interpretation of cash dividends
Next, we delve into cash dividends.
The gross mistake while interpreting dividends in our country is reporting dividends as a % of face value.
The face value of a share has little to no relevance to a company's fair value.
A company with shares face value of 10 can be worth nothing or can have fair value of thousands of Taka.
Have a look at the example above.
This company with earnings per share of Tk10 and dividends per share of Tk3 will report its dividend as 30% (dividend divided by face value) as per the Bangladeshi norm.
Many investors will look at this 30% number and express satisfaction over the announcement.
Yet, the dividend payout is 30% meaning the company has retained 70% of the earnings.
And the dividend yield (calculated as dividend divided by the stock price) is just around 1.5%.
Ignoring the justification for cash retention -- which we discuss in the next point -- it is clear that neither the payout or dividend yield is anything spectacular.
Tying dividends up with capital allocation
Declaring a large dividend does not make the company good and declaring zero dividends does not make a company bad.
It all boils down to a company's capital allocation decisions.
Surplus profit or cash flow can be obviously given out as dividends.
However, the company can also use the cash to finance expansion projects.
It can also acquire other businesses.
In foreign countries there is scope to buy back shares and reduce outstanding shares.
The main theory of capital allocation states that a company should pursue expansion or acquisitions if the internal rate of return (IRR) of those projects exceeds the cost of capital.
If no such projects are available or there is surplus cash there is strong justification for giving the surplus out as dividends.
Otherwise, a growing company can continue to reinvest in the business and not pay out any dividends.
Conclusion
The misunderstanding of dividends leads to mispricing of listed companies.
Sometimes investors overreact to large stock dividends which have no implication.
Other times they penalize companies with low dividends even though the company is pursuing a profitable expansion strategy.
In addition, our policies are also often wrongly designed by giving stock dividends the same weight as cash dividends.
This is currently true while categorizing companies in the stock market.
A thorough reeducation of investors and other stakeholders will help solve these problems and lead to a more efficient capital market.
The author is chairman of EDGE AMC Ltd and co-founder of EDGE Research and Consulting Ltd. All views expressed here are personal