Imagine that you own a property, but you don't have the option of renting it or using it personally. In this scenario, why keep this property? The answer lies in the expectation that you will be able to sell it for more than what you paid. In the world of finance, a similar dynamic occurs, where investors bet on the appreciation of assets , planning to sell them later at a profit . However, this strategy can often turn out to be an investment illusion.
When should a company retain profits?
A company should only retain profits , instead of distributing dividends, if it has projects that bring superior returns to shareholders . As a result, future profits will be greater, and there is an understanding that the sacrifice of not receiving dividends will be compensated at some point in the future. However, some companies retain profit but do not use it in projects that increase profitability , resulting in wasted resources. Let's analyze an example.
Let's analyze the performance of a company whose name has been omitted. This company has distributed dividends every year since 2017. However, over five years, dividends per share went from R$1 to R$1.27, representing a modest growth of 27%. Now, consider the following scenario: in 2017, if the company had reinvested the retained R$1.36 per share , this would have generated an estimated value of R$0.136 per share for shareholders in the following year. This, in fact, occurred in 2018, when the company's profit increased from R$2.36 to R$2.55. The positive trend continued in 2019, with profits rising from R$2.55 to R$2.77. However, starting in 2019, the company faced difficulties effectively employing retained earnings , which resulted in two consecutive years of lower profits than those reported in 2019.
The ineffectiveness in reinvesting properly took away shareholder value , which is evident in the drop in the share price , which went from R$37 to R$27.00. Therefore, it is necessary to evaluate the quality of profit reinvestment before considering investing in an asset that retains a large part of profits . If the company fails to allocate resources, the shareholder must demand a higher pay-out.
How to Avoid Losses?
Focus on the fundamentals and see how the company stands in terms of financial. Remember that in times of recession, it is more solid companies who have the ability to overcome headwinds.
Check who the customers are
If a company has a broad customer base, the loss of one of them is not so problematic, as others will continue to consume, contributing to the sales amount.
Check Customer Contracts
Check the expiration of contracts with key customers. For example, if you are interested in investing in a highway concessionaire, always ask when the contract will expire with the government, state, or municipality.
Work with the help of a CNPI Analyst
Finally, don't act alone; always seek help from a CNPI analyst , the only finance professional that can evaluate and make recommendations for investment products.
Contact analyst Wagner Geremia.
What is the Investment Illusion?
Investing in shares may seem like a simple task: you open your bank's app, type the ticker, enter the password and, that's it, you've become an investor . However, the reality is that investing requires a high degree of research and analysis of macroeconomic as well as microeconomic factors. As we discussed in the previous post , the other side of the equation, which involves the indiscriminate distribution of dividends , also represents a significant risk to the investor, in what I called the dividend trap . Therefore, investing requires knowledge, effort, common sense and a touch of luck.