How does stock price and dividends reflect the value of the firm - Term Paper Example

For example, if a corporation issues 100 shares in total, each share provides 1% ownership to the shareholder in the company. Share prices can increase or decrease based on the market conditions and the performances of the company. Corporations often keep certain percentage of its annual profits for future expansion of the company and pay certain percentage of the profits to its shareholders. The annual profit paid to the shareholders by the company is often referred as dividends. The amount of dividend supplied to the shareholders in a particular year depends on the profit achieved by the company in that particular year.

In other words, when the company gets more profits, the shareholders get more dividends and vice versa. This paper analyses the importance of stock price and dividends with respect to the value of the firm. “A company's worth - its total value - is its market capitalization, and it is represented by the company's stock price. Market cap is equal to the stock price multiplied by the number of shares outstanding” (What is a company's worth, and who determines its stock price?, 2011). When the company grows or performs well, its share prices will increase whereas when the company underperforms, its share prices will decreases.

When a company shows signs of growth, more demand will be created in the share market for its shares. Share purchasers often offer higher prices to the shares of growing companies and the shareholders who sell their share or stake in a growing company may get higher prices in the share market. “A company’s value for many investors is its ability to generate a satisfactory return over a long holding period. A number of things including financial strength, market dominance, growth potential, and so on, determines that value” (Little, 2011).

For example, recently, the share value of many companies dropped drastically because of global financial crisis; however the share value of many other companies did not undergo many fluctuations as a result of the recent crisis. The companies which performed better in share market even in the crisis situations are generally perceived as better companies and the investors may invest more heavily in those shares. The share prices of better performing companies may not dip drastically even in unfavorable market conditions.

In short, share price of a company is directly proportional to the growth of the company; when the company grows, the share prices will increase and when the company underperforms, share prices will decrease. Since dividend is a portion of annual profit made by a company, no company would be able to pay dividends to the shareholders when it underperforms. At the same time, it is not necessary that a company which is able to pay higher dividends is better than some other companies which are paying fewer dividends or no dividends at all.

The value of the company can be better judged based on its operations or activities. Only by generating more cash than it needs to finance its operating plan, should a company pay a dividend. Thus, for a company like Google with attractive growth opportunities, dividends are basically irrelevant to estimate its value. For mature companies, late in their life-cycle, paying dividends is a way to ensure management does not waste funds on silly projects, or build empires. Further, when a company is relatively mature, and it establishes a well-communicated dividend program, it attracts a particular investor