Shareholder rewards (AQA A Level Business): Revision Note

What are shareholder rewards?

• The payment made to shareholders from profits is called a dividend

  • They are one of the two main ways shareholders benefit from owning shares

  • The other benefit is capital growth — an increase in the value of the shares themselves

• When a business makes a profit, it faces a key decision

  • How much of that profit should be retained within the business for reinvestment?

  • How much should be distributed to shareholders as a reward for their investment?

• Two key quantitative measures are used to assess the attractiveness of investment in a company

  • Dividend per share

  • Dividend yield

Dividend per share

• Dividend per share is the total amount of dividend paid by the company, divided by the number of shares in issue

  • It tells each shareholder how much income they will receive for every share they own

• It is expressed in pence and calculated using the formula

$\mathrm{Dividend}\mathrm{per}\mathrm{share}=\frac{\mathrm{Total}\mathrm{dividends}\mathrm{paid}}{\mathrm{Number}\mathrm{of}\mathrm{ordinary}\mathrm{shares}\mathrm{issued}}$

Interpreting dividend per share

• Dividend per share is a straightforward and transparent measure of the income a shareholder receives in return for taking a risk in investing

• However, it has limited value on its own

  • 27p per share means very little without knowing what those shares cost to buy or what rival companies are paying

  • A shareholder investing £5 per share and receiving 27p is in a very different position to one who paid £1 per share for the same return

• Dividend per share is most useful for tracking whether dividend payments are growing, stable or declining over time

  • A consistent or rising dividend per share indicates financial confidence

  • A lower dividend per share is often interpreted as a warning sign that the business is under financial pressure

Dividend yield

• Dividend yield expresses the dividend per share as a percentage of the current share price

  • It measures the income return an investor earns relative to the price they pay for the shares

  • This makes it more useful than dividend per share alone for comparing investment opportunities

• It is expressed as a percentage and calculated using the formula

$\mathrm{Dividend}\mathrm{per}\mathrm{share}=\frac{\mathrm{Dividend}\mathrm{per}\mathrm{share}}{\mathrm{Share}\mathrm{price}}\times 100$

Interpreting dividend yield

• Dividend yield can be compared directly with other investments

  • Other companies' dividend yields

    • To assess whether a business offers a more or less attractive income return than its competitors

  • Interest rates on savings accounts

    • If a savings account offers 5.75% and Hartford Retail Plc's dividend yield is 10.59%, the shares offer a higher income return, though with greater risk

• It can also be compared with the company's own historical yield to assess whether the dividend is becoming more or less generous over time

Dividend yield and changes in the share price

• Dividend yield changes whenever the share price changes, even if the dividend itself stays the same

• A high dividend yield is not always simply the result of a generous dividend

  • It may also reflect a falling share price, which could indicate investors have concerns about the business

Shareholder rewards in context

• Dividend figures should never be analysed in isolation

  • To form a meaningful judgement, they should be assessed in relation to the business's objectives, competitors, planning and its broader context

Business objectives

• A company's dividend policy reflects its priorities

  • A business focused on rapid growth will typically retain a large proportion of its profits for reinvestment

    • This means lower dividends in the short term

  • A mature business with limited growth opportunities may pay out a higher proportion of profit as dividends

    • It prioritises income returns for shareholders

Example

A technology start-up that has just floated on the stock market is unlikely to pay any dividend at all.

Its profits are reinvested to fund product development and market expansion. Shareholders invest expecting capital growth, not income.

By contrast, a long-established supermarket chain with stable, predictable profits pays a consistent and growing dividend.

This attracts investors who are keen to generate a regular income.

Competitors and benchmarking

• Dividend yield should be compared against competitors' and industry averages

• If Hartford Retail plc offers a yield of 8.88% while its main competitors offer 4–6%, this could indicate one of two things

  • Hartford is unusually generous

  • Its share price has fallen significantly

    • This could reflect investor concerns about future performance

• Context determines which interpretation is correct

Business planning and retained profit

• Every pound paid as a dividend is a pound that cannot be reinvested in the business

• Companies must balance rewarding shareholders with the need to retain funds for investment, debt repayment or financial stability

Example

A retailer planning to open twenty new stores over the next three years may reduce its dividend to retain more profit for capital investment.

Shareholders who understand the strategy may accept a lower short-term income in exchange for the prospect of higher future returns.

• A business facing cash flow difficulties may also cut or suspend its dividend to prioritise solvency over shareholder income

  • While this may disappoint investors in the short term, it may be necessary for the long-term survival of the business

Context of the business

• The stage of the business lifecycle, current trading conditions and the economic environment all influence dividend decisions and the interpretation of dividend data

  • A business reporting a high dividend yield during a period of economic difficulty may be maintaining its dividend to reassure investors, even if this stretches its finances

  • A business cutting its dividend during a downturn may be acting sensibly by preserving cash in difficult conditions

    • It is not necessarily a sign of a fundamental weakness

  • A brand-new company that has never paid dividends cannot be fairly compared on yield to a long-established business

    • The two attract very different types of investor, with very different expectations