A company that is earning money has three options when declaring a profit.Originally Posted by SBQ
a/ Pay out all the earnings as a dividend to shareholders.
b/ Keep all the earnings and reinvest those in the business, and in doing so provide extra capital that will enable the business to grow
c/ Choose a combination of paying out a dividend with some of the profit and retaining the rest to help the business grow.
Which strategy is used depends on what kind of market the company is in and whether that market is static shrinking or growing. A company should only retain capital if they can reinvest those retained earnings and be sure that any resulting incremental investment earns more than its cost of capital. If they can't do this, then the company should pay out to share holders all of their earnings as dividends, and let shareholders decide where to reinvest that money for themselves. In this situation, it is absolutely the right thing to do to pay out all the company's earnings as dividends. It would actually be foolish not to do so!
Getting a dividend from a New Zealand company is generally very tax effective. That is because if the company has paid tax on their earnings, you as a shareholder should not as a rule have to pay tax again on that same money.
It is true that capital gains for long term investors carry no tax liability. But it is also true that capital losses for long term investors carry no tax deductibility. So I would challenge the statement that capital gains are more tax effective than dividends for NZ investors in NZ companies.
One particular problem I have noticed with the NZ market is that good growth companies need about five years of operations under the belt to really prove themselves. But so often, five years is enough to gain near market saturation in New Zealand. This means it is very possible to buy an NZ company with a 'proven growth record' only to have the growth story fall apart in year six.
Buyer beware!
SNOOPY
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