Read the following passages and summarize 2 main points.

shares should consistently sell at prices reasonably related to busi ness value.30 C. Dividend Policys Dividend policy is often rted to shareholders, but seldom explained. A company will sa nething like, "Our goal is to pay out 40% to 50% of earnings db increase dividends at a rate at And that's it-no analysis will be supplied as to why that particular policy is best for the owners of the business. Yet, allocation of capital is crucial to business and investment management. Because it is, we believe managers and owners should think hard about the circumstances under which earnings should be retained and under which they should be least equal to the rise in the The first point to understand is that all earnings are not cre- ated equal. In many businesses-particularly those that have high asset profit ratios-inflation causes some or all of the reported earnings to become ersatz. The ersatz portion-let's call these earnings "restricted"-cannot, if the business is to retain its eco- nomic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas: its ability to maintain its unit volume of sales, its long-term competitive position, its financial strength. No matter how conservative its payout ratio, a company that consistently dis tributes restricted earnings is destined for oblivion unless equity capital is otherwise infused Restricted earnings are seldom valueless to owners, but they often must be discounted heavily. In effect, they are conscripted by the business, no matter how poor its economic potential. (This re- tention-no-matter-how-unattractive-the-return situation was com municated unwittingly in a marvelously ironic way by Consolidated Edison a decade ago. At the time, a punitive regulatory policy was a major factor causing the company's stock to sell as low as one- fourth of book value: i.e., every time a dollar of earnings was re tained for reinvestment in the business, that dollar was trans formed into only 25e of market value. But, despite this gold-into- lead process, most earnings were reinvested in the business rather aid to owners. Meanwhile, at construction and maintenance sites throughout New York, signs proudly proclaimed the corpo- rate slogan, "Dig We Must".) Restricted earnings need not concern us further in this divi dend discussion. Let's turn to the much-more-valued unrestricted variety. These earnings may, with equal feasibility, be retained or distributed. In our opinion, management should choose whichever course makes greater sense for the owners of the business. This principle is not universally accepted. For a number of reasons managers like to withhold unrestricted, readily distributa- the corporate empire ble earnings from shareholders-to expand over which the managers rule, to operate from a position of excep- al financial comfort, etc. But we believe there is only one valid reason fo only when there is a reasonable prospect-backed preferably by historical evidence or, when appropriate, by a thoughtful analysis of the future-that for every dollar retained by the corporation, at least one dollar o happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors. r retention. Unrestricted earnings should be retained fmarket value will be created for owners. This will To illustrate, let's assume that an investor owns a risk-free 10% perpetual bond with one very unusual feature. Each year the investor can elect either to take his 10% coupon in cash, or to rein vest the coupon in more 10% bonds with identical terms: i.e., a perpetual life and coupons offering the same cash-or-reinvest op- tions. If, erm, risk-free bonds is 5%, it would be foolish for the investor to take his coupon in cash since the 10% bonds he could instead choose would be worth considerably more than 100c on the dollar in any given year, the prevailing interest rate on long- Under these circumstances, the investor wanting to get his hands on cash should take his coupon in additional bonds and then imme