CandleFocus Glossary Editor
The Bird in Hand Theory refers to an approach to investing in which investors prefer stock dividends to the potential for capital gains. This theory, which serves as an alternative to the Modigliani-Miller Dividend Irrelevance Theory, highlights the uncertainty and to an extent, the risk associated when one is looking to capitalize on capital gains from their investments.
Investors have always had a tendency to affiliate safety to income from dividends, as this provides them with a more certain return than from capital gains. The dividend payments that a company provides represent the tangible cash (a “Bird in Hand”) that is currently being distributed to investors. By contrast, capital gains are potentially more rewarding, but due to their unpredictable nature, they leave investors uncertain as to when they will actually materialize.
The Bird in Hand Theory attempts to dispute the Modigliani-Miller hypothesis by point that investors tend to prefer a certain cash dividend payment today over the potential for capital gains tomorrow. This opinion suggests that investors don’t put total emphasis on the dividends, but they hold great sensibility towards being presented with the option of actually receiving a share of the company’s profits allocated to them as shareholders. The concept further implies that given the choice, investors would tend to prefer dividends today than the promise of capital gains tomorrow without the certainty of the timing of when a capital gain might materialize.
All in all, the implications of the Bird in Hand Theory suggest that the stock market is usually more strongly driven by the concept of the rewards of dividends today than the uncertain investment income from capital gains in the future. Therefore, if investors have the choice, they usually prefer to receive a consistent dividend return than to speculate and invest for capital gains. Since dividends can never fall as a result of stock market fluctuations, it can be argued that this type of investment offers a certain level of assurance and peace of mind - which is why investors show a preference for the bird in their hand over the two in the bush.
Investors have always had a tendency to affiliate safety to income from dividends, as this provides them with a more certain return than from capital gains. The dividend payments that a company provides represent the tangible cash (a “Bird in Hand”) that is currently being distributed to investors. By contrast, capital gains are potentially more rewarding, but due to their unpredictable nature, they leave investors uncertain as to when they will actually materialize.
The Bird in Hand Theory attempts to dispute the Modigliani-Miller hypothesis by point that investors tend to prefer a certain cash dividend payment today over the potential for capital gains tomorrow. This opinion suggests that investors don’t put total emphasis on the dividends, but they hold great sensibility towards being presented with the option of actually receiving a share of the company’s profits allocated to them as shareholders. The concept further implies that given the choice, investors would tend to prefer dividends today than the promise of capital gains tomorrow without the certainty of the timing of when a capital gain might materialize.
All in all, the implications of the Bird in Hand Theory suggest that the stock market is usually more strongly driven by the concept of the rewards of dividends today than the uncertain investment income from capital gains in the future. Therefore, if investors have the choice, they usually prefer to receive a consistent dividend return than to speculate and invest for capital gains. Since dividends can never fall as a result of stock market fluctuations, it can be argued that this type of investment offers a certain level of assurance and peace of mind - which is why investors show a preference for the bird in their hand over the two in the bush.