What is the 'Clientele Effect'?

The clientele effect is a theory that explains how a company's stock price will move according to the demands and goals of investors in reaction to a tax, a dividend or another policy change. The clientele effect first assumes that specific investors are attracted to different company policies and that when a company's policy changes, investors will adjust their stock holdings accordingly. As a result of this adjustment, the stock price will move up or down.

BREAKING DOWN 'Clientele Effect'

The best way to explain the clientele effect is to describe how the effect explains investors' reactions. Public equities are typically categorized in different ways such as dividend-paying stocks, high-growth stocks, blue-chip stocks or mature stocks. Each categorization is associated with the lifecycle of a business and the manner in which its stock provides returns to investors. A high-growth stock, for example, will not pay a dividend, but it may have huge swings in price appreciation as the company grows. A dividend-paying stock, on the other hand, has smaller movements in capital gains but rewards investors with stable, quarterly dividends.

Two Sides of the Clientele Effect

The first side of the clientele effect describes the way in which certain investors – or clients – seek out stocks in a specific category. Some investors, like Warren Buffett, try to only invest in stocks with a high dividend, whereas other investors, such as technology investors, seek companies that are high-growth with the potential for high capital gains. Thus, the clientele effect first outlines the way in which the company's maturity and business operations initially attract a certain type of investor.

The second side of the clientele effect describes how current investors react when there are changes to a company's policies and procedures. If, for example, a public technology stock pays no dividends and reinvests all of its profits back into the company, it first attracts a growth investor. Then, if the company decides to stop reinvesting in its growth and instead pay a dividend, high-growth investors may exit their positions and instead seek other stocks with high-growth potential. Dividend-seeking income investors may now see the technology company as an attractive investment. This explains the second meaning of the clientele effect, which has an impact on the company's share price.

Consider a company that already pays a dividend and has attracted clientele whose investment goal is to obtain stock with a high dividend payout. If the company then decides to decrease its dividend, dividend investors may still sell their stock and invest in another company that pays a higher dividend. As a result, the company's share price will decline.

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