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Introduction to credit operating leverage
For the last couple of years the broad economy has experienced an extraordinarily high level of operating leverage and consequently since 2000, companies have cut costs. The best evidence of that elevated level of operating leverage is the very low rate of industrial capacity utilization. Despite the modest improvement since 2001, utilization is still at levels not seen since the 1982 recession. On the one hand, that is a sign that businesses continue to suffer from overcapacity. Looked at it another way, however, the low-but-improving rate of capacity utilization is an indication that profits may grow above average in the future.
What value is value?
One of the great marketing tools for stocks is the promise that there is a product that will work for every investor. Companies, brokerage firms, and mutual fund houses are constantly putting out new products to sell to discouraged investors. Financial professionals never miss an opportunity to sell a gullible investor a stock. They have invented a wrench to fit every nut.
No stock style or category eliminates the basic problem with stocks. Style is supposed to take the sting out of investing. Unfortunately, all stocks, regardless of category, are subject to the whims of the herd.
Utility stocks are marketed as steady income vehicles akin to Treasury bonds, yet they are often as volatile as tech stocks. Utility stock prices were cut in half when Three Mile Island threatened to ruin the power business.
They were whacked again when deregulation eliminated their monopoly position in many markets. Recently, increased gas prices sent the once steady and reliable PG&E into bankruptcy and put Southern California Edison on the brink of bankruptcy.
Each type of stock creates its own emotional complexities. Preferred stock was one of the marketer’s first products. When common stock investors realized that in financial stress, the company canceled dividends but paid bond interest, they sold stock and bought bonds. Companies then began to issue preferred stock with fixed dividends. Preferred stock dividends are paid when a company is in stress, but in bankruptcy, preferred stock is canceled, the same as common stock. Few investors are comfortable with this netherworld between bonds and stocks. The complexity of determining how to value preferred stock keeps many investors away. These days stock is considered a pure capital gains vehicle and bonds are used for income.
Get professional advice now – it may save you from the Crisis
Currently more and more people are forced to struggle with financial hardship. However, fewer seem to be willing or, perhaps, simply able to contact a financial expert to get a professional advice on their finances that will assist them in such difficult times. I cannot stress it strongly enough how important the need for professional advice regarding finances is now, and believe me, it has never been more crucial than in the times of financial turbulence we are witnessing now.
Because the banking sector is under pressure too, you simply must keep your financial affairs in order and inform your bank about any change in your position. It is quite possible that if you decide to approach a bank in the future, treating is as a last resort, they will just turn you down for some sort of financial repackaging.
All too often people seem to forget that the citizens advice bureau is also available in difficult times and provide free advice and information for those struggling with any type of financial hardship. You might feel the urge to bury your head in the sand in hope that your financial problems will disappear in due course, but unfortunately this will not happen. If you act upon the first symptoms of financial trouble you are more likely to get a favorable result in the long run.
Overview of the Dividend Policy Decision
In practice, dividend policy is not an independent decision—the dividend decision is made jointly with capital structure and capital budgeting decisions. The underlying reason for joining these decisions is asymmetric information, which influences managerial actions in two ways:
- In general, managers do not want to issue new common stock. First, new common stock involves issuance costs—commissions, fees, and so on—and those costs can be avoided by using retained earnings to finance equity needs. Second, as we discussed previously, asymmetric information causes investors to view new common stock issues as negative signals and thus lowers expectations regarding the firm’s future prospects. The end result is that the announcement of a new stock issue usually leads to a decrease in the stock price. Considering the total costs involved, including both issuance and asymmetric information costs, managers prefer to use retained earnings as the primary source of new equity.
- Dividend changes provide signals about managers’ beliefs as to their firms’ future prospects. Thus, dividend reductions generally have a significant negative effect on a firm’s stock price. Since managers recognize this, they try to set dollar dividends low enough so that there is only a remote chance that the dividend will have to be reduced in the future.
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