What is the 'Dividend Irrelevance Theory'

The dividend irrelevance theory is the theory that investors do not need to concern themselves with a company's dividend policy since they have the option to sell a portion of their portfolio of equities if they want cash.

BREAKING DOWN 'Dividend Irrelevance Theory'

The dividend irrelevance theory indicates that a company’s declaration and payment of dividends should have little to no impact on stock price. If this theory holds true, it would mean that dividends do not add value to a company’s stock price.

Yet studies show that stocks that do pay a dividend, like many blue chip stocks, often increase in price by the amount of the dividend as the book closure date approaches. Although the dividend may not actually be paid until a few days after this date, given the logistics of processing such a large number of payments, the price of the stock usually drops again the amount of the dividend. Buyers after this date are no longer entitled to the dividend. These practical examples can conflict with the dividend irrelevance theory.

Analysts conduct valuation exercises to determine a stock’s intrinsic value. These often incorporate factors, such as dividend payments, along with financial performance, and qualitative measurements, including management quality, economic factors, and an understanding of the company’s position in the industry.

Dividend Irrelevance Theory and Portfolio Strategies

Despite the dividend irrelevance theory many investors focus on dividends when managing their portfolios. For example, a current income strategy seeks to identify investments that pay above average distributions (i.e. dividends and interest payments). While relatively risk-averse overall, current income strategies can be included in a range of allocation decisions across a gradient of risk.

Strategies focused on income are usually appropriate for investors in need of stable, established entities that will pay consistently (i.e. without risk of default or missing a dividend payment deadline). These investors might be older and/or willing to take on fewer risks. Dividends may feature in a range of other portfolio strategies, as well, such as preservation of capital.

Blue chip companies generally pay steady dividends. These are multinational firms that have been in operation for a number of years, including Coca-Cola, Disney, PepsiCo, Wal-Mart, General Electric, IBM, and McDonald’s. These companies are dominant leaders in their respective industries. and have built highly reputable brands, surviving multiple downturns in the economy.

  1. Dividend Policy

    Dividend policy structures the dividend payout a company distributes ...
  2. Dividend Signaling

    Dividend signaling suggests that a company announcement of an ...
  3. Stock Dividend

    A stock dividend, also known as a scrip dividend, is a dividend ...
  4. Final Dividend

    The final dividend is declared at a company's Annual General ...
  5. Accumulated Dividend

    An accumulated dividend is a dividend on a share of cumulative ...
  6. Dividend Yield

    A financial ratio that shows how much a company pays out in dividends ...
Related Articles
  1. Investing

    The 3 Biggest Misconceptions of Dividend Stocks

    Learn about three dividend stock misconceptions and how to avoid them for greater gains.
  2. Investing

    The Top 5 Dividend Paying Oil Stocks for 2016

    Discover the top five dividend-paying oil companies for 2016 and what factors contribute to their ability to continue dividend payments.
  3. Financial Advisor

    How mutual funds pay dividends: An overview

    The process by which mutual fund dividends are calculated, distributed and reported is fairly straightforward in most cases. Here's a look.
  4. Investing

    5 Reasons Why Dividends Matter to Investors

    Learn five of the primary reasons why dividends are of significant importance for the overall performance of stock market investments.
  5. Investing

    Dividends Still Look Good After All These Years

    Find out how this "first love" still holds its bloom as it ages.
  6. Financial Advisor

    4 Reasons a Company Might Suspend Its Dividend

    Learn about the four most common reasons a company may choose to suspends its dividends, including financial trouble, funding growth and unexpected expenses.
  7. Investing

    The Top 5 Dividend Paying Software Stocks for 2016 (MSFT, INFY)

    Find out which five dividend-paying stocks in the software sector can bring the best yields and growth potential to your portfolio.
  1. Are dividends considered assets?

    Find out why dividends are considered an asset for investors, but a liability for the company that issued them. Learn the ... Read Answer >>
Trading Center