Reflection on Bird in the Hand Theory

When I was in college, I remember my finance professor talked about bird in the hand theory in the classroom, I paused for a while as I was wondering what is the relationship between a bird and finance theory.

 

He went on to explain that the theory postulates investors prefer dividends compared to capital gains as capital gains can be highly uncertain.

Hence, bird in the hand (dividend) is worth two in the bush! (referring to capital gains).

What the theory miss out is that the bird in the bush may fly higher, giving investor good capital gains!

There is also dividend irrelevance theory where it postulates that investor could sell shares and realise the capital gain and treat it as a dividend, hence dividend policy should have little or no impact to share price.

What the theory miss out is that dividend does have an impact on a company’s share price, imagine if a company keeps increasing or cuts its dividend, there is a high probability that the share price of the firm might react positively or negatively.

As an income investor, we should value the stream of sustainable dividends paid by the companies, but it doesn’t mean we will neglect the potential capital gain over the long run.

We want BOTH.

Dividend + Capital Gains = Total Return

By investing into quality companies that pay sustainable and rising dividends, its share prices are likely to increase over the long run, giving a BOOST to investor’s total return in holding the specific stock.

No matter where the bird is, either in the hand or in the bush, it will be great to capture BOTH.