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Dividends 8


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Dividends 8

  1. 1. The Basic Decision <ul><li>Cash from operations </li></ul><ul><li>Dividends </li></ul><ul><li>Stock repurchase </li></ul><ul><li>Investments </li></ul><ul><li>Borrowings </li></ul><ul><li>Equity issue </li></ul>
  2. 2. Dividends <ul><li>Irrelevance of dividends </li></ul><ul><li>Current dividends versus capital gains (Retention of earnings) </li></ul><ul><li>ROI versus cost of capital </li></ul><ul><li>Invest when ROI > COC </li></ul><ul><li>Return money to shareholders when ROI < COC </li></ul>
  3. 3. Different Types of Dividends <ul><li>Many companies pay a regular cash dividend . </li></ul><ul><ul><li>Public companies often pay quarterly. </li></ul></ul><ul><ul><li>Sometimes firms will throw in an extra cash dividend. </li></ul></ul><ul><ul><li>The extreme case would be a liquidating dividend. </li></ul></ul><ul><li>Often companies will declare stock dividends. </li></ul><ul><ul><li>No cash leaves the firm. </li></ul></ul><ul><ul><li>The firm increases the number of shares outstanding. </li></ul></ul><ul><li>Some companies declare a dividend in kind . </li></ul><ul><ul><li>Wrigley’s Gum sends around a box of chewing gum. </li></ul></ul><ul><ul><li>Dundee Crematoria offers shareholders discounted cremations. </li></ul></ul>
  4. 4. Stock Repurchase <ul><li>Alternate to payment of cash dividends </li></ul><ul><li>Taxability </li></ul><ul><li>Shareholders profile. </li></ul><ul><li>Retail : Lower capital gains versus tax on dividends </li></ul><ul><li>Institutional : Tax free entity </li></ul>
  5. 5. Cash Dividend –Repurchase Equivalence <ul><li>Earnings = 6000. No of shares =1000. EPS =6 </li></ul><ul><li>P/E ratio = 4.5 Market Price = 27. Dividend = 3 </li></ul><ul><li>Total value = 27+3 =30 </li></ul>
  6. 6. <ul><li>Alternative : To buyback shares at Rs 30 </li></ul><ul><li>No of shares purchased = 3000/30 = 100 </li></ul><ul><li>Balance shares 900 </li></ul><ul><li>New EPS = 6000/ 900 = 6.67 </li></ul><ul><li>Market Price = 6.67* 4.5 = 30 </li></ul>
  7. 7. Two Decisions <ul><li>Return money to shareholders </li></ul><ul><li>Dividend versus Stock buyback </li></ul>
  8. 8. The MM Hypothesis <ul><li>The irrelevence argument </li></ul><ul><li>Dividends & valuation </li></ul><ul><li>Leverage irrelevence theorem. Raising of external finance. </li></ul>
  9. 9. The Rightists <ul><li>Traditional Belief </li></ul><ul><li>Market imperfections </li></ul><ul><li>Free cashflow hypothesis </li></ul>
  10. 10. The Radical Left <ul><li>Dividends vis-à-vis Stock repurchase </li></ul><ul><li>Zero payouts? </li></ul>
  11. 11. Lintner Model <ul><li>Firms have long run target dividend payout ratios. Mature companies with stable earnings generally pay out a high proportion of earnings. Growth companies have low payouts. </li></ul><ul><li>Managers focus more on dividend changes than on absolute levels. Thus, paying a Rupee 2.00 dividend is an important financial decision if last year’s dividend was rupee 1.00, but no big deal if last year’s dividend was Rupees 2.00. </li></ul>
  12. 12. Lintner Model cont… <ul><li>Dividend changes follow shifts in long run sustainable earnings. Managers “smoothen” dividends. Transitory earning changes are unlikely to affect dividend payouts. </li></ul><ul><li>Managers are reluctant to make dividend changes that they may have to reverse. They are particularly worried about having to rescind a dividend increase. </li></ul>
  13. 13. Influences on Dividend Policy <ul><li>Legal rules </li></ul><ul><li>Funding needs and liquidity </li></ul><ul><li>Ability to borrow </li></ul><ul><li>Debt covenants </li></ul>
  14. 14. Dividend Relevance <ul><li>Investor preference for dividends </li></ul><ul><li>Taxability </li></ul><ul><li>Floatation and transaction costs </li></ul><ul><li>Institutional restrictions </li></ul><ul><li>Financial signaling </li></ul>
  15. 15. Georgia Pacific <ul><li>We believe a portion of our cashflows should be paid to our shareholders as regular, sustainable, quarterly dividends. Currently, the Group pays a $0.25 per share quarterly dividend. In the future, the dividend rate will depend on our cashflows, long term capital requirements and overall capital structure. </li></ul><ul><li>As was the case in 1998, there likely will be periods when Georgia Pacific generates cash in excess of our opportunities for investments and dividends. Excess cash will be returned to our shareholders thru share repurchases, so they can make their own reinvestment choices. We believe our long term shareholders will benefit as their proportionate share of the Group grows. </li></ul><ul><li>Management is authorised to repurchase shares when total debt is below $4.75 billion. During 1998, Georgia repurchased 7.7 million shares. This represents a tax efficient distribution of $436 million to our shareholders and an 8% reduction from our January 1 share base. </li></ul>
  16. 16. Administrative Considerations <ul><li>Procedural aspects </li></ul><ul><li>Board Resolution </li></ul><ul><li>AGM approval </li></ul><ul><li>Record date </li></ul><ul><li>Cum dividend and Ex dividend </li></ul><ul><li>Payment date </li></ul><ul><li>Dividend reinvestment plan </li></ul>
  17. 17. Procedure for Cash Dividend Payment 25 Oct. 1 Nov. 2 Nov. 6 Nov. 7 Dec. Declaration Date Cum-dividend Date Ex-dividend Date Record Date Payment Date … Declaration Date : The Board of Directors declares a payment of dividends. Cum-Dividend Date : The last day that the buyer of a stock is entitled to the dividend. Ex-Dividend Date : The first day that the seller of a stock is entitled to the dividend. Record Date : The corporation prepares a list of all individuals believed to be stockholders as of 6 November.
  18. 18. Price Behavior around the Ex-Dividend Date <ul><li>In a perfect world, the stock price will fall by the amount of the dividend on the ex-dividend date. </li></ul>$ P $ P - div Ex-dividend Date The price drops by the amount of the cash dividend - t … -2 -1 0 +1 +2 … Taxes complicate things a bit. Empirically, the price drop is less than the dividend and occurs within the first few minutes of the ex-date.
  19. 19. Stock Splits <ul><li>Stock dividends </li></ul><ul><li>Stock splits </li></ul><ul><li>Effect on cash dividends </li></ul><ul><li>More popular trading range </li></ul><ul><li>Informational content </li></ul><ul><li>Reverse stock splits </li></ul>
  20. 20. Motleys Fool <ul><li>Wondering whether to buy a stock before or after a split is like asking “ Should I eat this peanut-butter sandwich before or after Mom cuts it into half. </li></ul><ul><li>Stocks don’t become more inexpensive when they split. True, you get more shares. But each is worth less. Imagine you own 100 shares of STC. They are trading at $60 each and total $6000. When STC splits two-for-one, you will own 200 shares, worth $30 each. Total value $6000. Yawn. </li></ul><ul><li>Some people drool over stocks about to split, thinking the price will surge. Stock prices sometimes do pop a little on news of split. But these are artificial moves, sustainable only if the businesses grow to justify them. The real reason to smile at a split announcement is because it signals that the management is bullish. They are not likely to split their stock if they expect price to go down. </li></ul>
  21. 21. <ul><li>Splits come in many varieties, such as 3 for 2 split. There is even a reverse split when you end up with fewer shares, with each worth more. Reverse splits are usually emloyed by companies in trouble, to avoid looking like the penny stocks that they are. </li></ul><ul><li>Companies often split their stock so that the price will remain psychologically appealing. If Microsoft had not split seven times in the last decade, each share would be worth more than $6500. </li></ul><ul><li>With stocks, just as with any purchase, examine what you are getting, for the price. A low price might be inviting but a $200 stock can be much more of a bargain than a $20 stock. If your funds are limited, buy fewer shares. </li></ul><ul><li>It is always fun to own more shares., but splits are like getting change for a dollar. They are not cause for a celebration. </li></ul>