Sunday, November 6, 2011

Quality of Earnings: Chapter 10

Investors rely heavily on the financials that companies release. But managements have significant leeway when it comes to creating its results. In this book, Thornton O'Glove tells investors how to judge the quality of a company's earnings, in order to both protect against fraud and find value.

This chapter is about dividends. O'Glove makes it clear that investors should not rely heavily, if at all, on dividends in making their investment decisions.

Often, companies with poor business prospects up their dividends to keep share prices high. These dividends are funded through debt, through an increase in the payout ratio and/or through share issuances. O'Glove describes a few companies that paid increasing dividends despite having to increase debts and share counts to fund these payments.

High dividends also suggest that a company faces grim growth prospects, since it is choosing not to invest in R&D, marketing and other areas that may help the company grow profitably. If companies do have excess cash, O'Glove much prefers they go the route of share repurchases rather than dividends, due to the tax benefits.

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