ROE and expected return

[pmoonoi]

Carson Wrote:
——————————————————-
> pmoonoi - it will depend on whether the company is
> earning a ROE > COE no? If so, I would want the
> company to reinvest. If not, the company should
> pay out dividends until it is only reinvesting in
> projects that at least cover the cost of equity.
>
> Does that sound reasonable?
Yes that sound reasonable. So again assuming all else the same (ie free cash flow to equity shareholders is the same - irrespective company pays div or not), the co that does not pay dividend, the equity value per share would have drop due to a higher expected return. Now unless they are able to generate a ROE > COE and hence a higher FCFE, then probably the value per share could even higher. Either way, the expected return for non-dividend paying co would be higher to compensate the investors for the dividend reinvested back into the co.

 

[bchad]

Mobius Striptease Wrote:
——————————————————-
> bchadwick Wrote:
> ————————————————–
> —–
> > Remember that if you are a taxable investor,
> > dividends will force you to pay taxes (and
> usually
> > at a higher rate than capital appreciation),
> > whereas with capital gains, you pay taxes only
> > when you sell (and therefore bank the time
> value
> > of the tax). So if ROE = Ke or even a tiny bit
> > less, you might prefer the company to retain
> > earnings so you don’t pay taxes on
> dividends(and
> > transaction costs on reinvestment) and have the
> > company do it for you. This might to be one
> > reason that excess cash is often used to
> > repurchase shares rather than pay dividends
> (the
> > other might be that management thinks shares
> are
> > undervalued).
> >
> > (yeah, it’s nit-picking a bit, but something to
> > remember)
>
>
> that’s an interesting point, although as long as
> the tax on dividends is the same as the capital
> gains tax, it shouldn’t make a difference to you.
> aren’t they the same in the US?
If dividends and cap gains taxes are taxed at the same rate, then the distinction is less significant, but you still gain by deferring taxes as long as you can (and therefore by waiting until you sell, rather than pay as dividends come in). The difference is basically the time value of the tax liability. With dividends, you don’t get to compound the deferred tax (of which only part of the compounding is taxable).
In the US right now dividends and long term cap gains are currently taxed at the same rate, but for individuals at least, short term capital gains are taxed as ordinary income. These provisions are supposed to expire in the next few years, and dividends would be taxed as ordinary income and cap gains would jump back to 20%.