Dividend Policy - The Pay Out Decision CORP FINC 5880- Session 2 MOOC Fall 2- 2015 Textbook: Chapter 19 After Class PPT with solution of class assignment

The Finance Framework

Dividends and the life cycle…

Cash Dividends…

5 Characteristics of Dividends Sticky Follow Earnings Effected by Tax Regime Buybacks > Dividends Differences by Country

1) Dividends are sticky…

Updated 2009-2014

2) Dividends follow earnings…

Updated 2009-2013

And up to 2014…

3) Are effected by tax laws

Dividend Tax versus Capital Gains tax

Dividend and Taxes

Dividend= Pb-Pa?

Intuitive implications:

If markets are inefficient: Arbitrage

Empirical Evidence…

4) More and more firms buy back shares instead of paying out dividends

Updated to 2014

5) There are differences between countries

About Pay Out and Yield Calculate Pay Out and Yield for your company Compare…

Updated…

Updated 2015

And Dividend Yields…

Measures of Dividend Policy Dividend Payout = Dividends/ Net Income Measures the percentage of earnings that the company pays in dividends Note: If the net income is negative, the payout ratio cannot be computed. Dividend Yield = Dividends per share/ Stock price Measures the return that an investor can make from dividends alone Becomes part of the expected return on the investment

Pay Out Ratios in the US (2010)

Dividend Yields in the US (2010)

Updated

In relation to growth

Dividends and the life cycle of s business…

The balanced viewpoint If a company has excess cash, and few good investment opportunities (NPV>0), returning money to stockholders (dividends or stock repurchases) is good. If a company does not have excess cash, and/or has several good investment opportunities (NPV>0), returning money to stockholders (dividends or stock purchases) is bad.

Ex dividend and Record dates As you can see by the diagram , if you buy on the ex-dividend date (Tuesday), which is only two business days before the date of record, you will not receive the dividend because your name will not appear in the company's record books until Friday. If you want to buy the stock and receive the dividend, you need to buy it on Monday. (When the stock is trading with the dividend the term cum dividend is used). But, if you want to sell the stock and still receive the dividend, you need to sell on or after Tuesday the 6th.

Dividends are good….but: Div Yield= a+b(Beta)+c(Age)+d(Income)+e(Tax diff) Variable Coefficient Implies Constant 4.22% Beta Coefficient - 2.145 Higher Beta stocks pay lower dividends Age/100 3.131 Firms with older investors pay more dividends Income/1000 -3.726 Firms with higher income investors pay less dividends Tax Differential - 2.849 If income is taxed at a higher rate than capital gains the firm pay less dividends

Dividends are good? Three “good” reasons for paying dividends… 1. Clientele Effect: The investors in your company like dividends. 2. The Signaling Story: Dividends can be signals to the market that you believe that you have good cash flow prospects in the future. 3. The Wealth Appropriation Story: Dividends are one way of transferring wealth from lenders to equity investors (this is good for equity investors but bad for lenders)

Dividend Matrix applied…

Peer Group analysis Disney…

More recent…

Peer Group analysis Deutsche Bank

Going beyond averages… Looking at the market Regressing dividend yield and payout against expected growth across all US companies in January 2009 yields: PYT = Dividend Payout Ratio = Dividends/Net Income YLD = Dividend Yield = Dividends/Current Price ROE = Return on Equity EGR = Expected growth rate in earnings over next 5 years (analyst estimates) STD = Standard deviation in equity values INS = Insider holdings as a percent of outstanding stock

Applied to Disney… To illustrate the applicability of the market regression in analyzing the dividend policy of Disney, we estimate the values of the independent variables in the regressions for the firm. • Insider holdings at Disney (as % of outstanding stock) = 7.70% • Standard Deviation in Disney stock prices = 19.30% • Disney’s ROE = 13.05% • Expected growth in earnings per share (Analyst estimates) = 14.50% Substituting into the regression equations for the dividend payout ratio and dividend yield, we estimate a predicted payout ratio: Predicted Payout = 0.683 – 0.185 (.1305) -1.07 (.1930) – 0.313 (.145) =0.4069 Predicted Yield = 0.039 – 0.039 (.1930) – 0.010 (.077) – 0.093 (.145) = .0172 Based on this analysis, Disney with its dividend yield of 1.67% and a payout ratio of approximately 20% is paying too little in dividends. This analysis, however, fails to factor in the huge stock buybacks made by Disney over the last few years.

Session 2 Assignments: We made 5 statements about dividends test the first 4 for your company! Draw conclusions. Measure pay out ratio and dividend yield for your company over the last at least 10 years and compare with it’s peer group (what is your conclusion? Show your data) Where is your company in the dividend matrix? Conclude… We performed a market regression January 2009 and drew conclusions on Disney; do the same for your company (see example Disney)

Signaling effect

How Much Cash is too Much? Concept of Cash Flow… Calculating FCE Comparing pay out And the Balance is?

Free Cash Flow to Equity What a company “could have returned” What the company actually “paid out” Why most companies are holding back cash… (do you trust management with your money?)

Free Cash Flow to Equity Walt Disney

Apple’s FCE? 10K ultimo Sept.2014 (In B USD) Net Income 39.5 Dep&Amort 8.0 Capex&ACQ -13.3 Change NWC 7.0 New Debt (Incl. CP) 18.2 FCE 59.4 Apple could have paid out 59.4 B USD Apple paid out 56.1 B USD (11.1 B USD dividends and 45 B USD repurchase of stock) Where did the difference of 3.3 B USD go?

And FY 2015 Apple…announced last week Net Income 53.4 Dep&Amort 11.3 Capex&ACQ -11.6 Change NWC 11.7 New Debt (Incl. CP) 29.3 FCE 94.1 Apple could have paid out 94.1 B USD Apple paid out 46.8 B USD (11.6 B USD dividends and 35.3 B USD repurchase of stock) Where did the difference of 47.3 B USD go? 7.2 B USD increase in cash and cash equivalents and 41 B USD increase in marketable securities….

Cash Flow FY2015

Balance sheet ultimo Sept 2015

Quick Case….on dividends

Class Assignment Dividends a) The Company currently has a Cash balance of $ 150 Million and expects this Cash Balance to drop to $ 50 Million by the end of Year 2018. If the Company pays out 60% of it’s Net Earnings over the next 5 years, how much Capital Expenditure does it plan to spend CUMULATIVE over the next 5 years? b) If the Company wants to maintain it’s cash balance (at the end of year 2018 still have $150 Million in cash) and over the next 5 years ALSO want to pay back all of it’s debt (debt balance at the end of 2018 is ZERO) what would be the average pay out ratio over the 5 year period (2014-2018).  

Answer Class Assignment