Week 6 Flashcards
What are the steps in the dividend decision?
- Cashflow from operations goes to cashflows to debt (based on how much was borrowed), and cashflows from operations to equity investment.
- Cashflows from operations to equity investors goes into reinvestment back into the business if we have good investment choices, or cash available to return to shareholders.
- Cash available for return to shareholds may be held back by the company to maintain a reasonable cash balance, or paid out to stock stockholders.
- The cash paid out to stockholders may be paid out by dividends or stock buybacks depending on what stockholders prefer.
What are some important things to remember about dividends?
Dividends are sticky, once a company has paid one, they typically need to keep paying it in subsequent periods. With an increase being far more common than a decrease. Dividends tend to follow earnings, rather than increasing at the same time or leading earnings. If a company’s earnings increase 2 years in a row we expect a higher chance of increasing dividend then if the earnings are high for one year, and so on. Dividends are affected by tax laws (lower dividend tax increases dividend rate).
Why are stock buybacks becoming more common?
Stock buybacks are becoming more common over time, rather than paying dividends. They are now more common than dividends, this is occurring for a few reasons: dividends are sticky, if earnings are volatile this can make dividends difficult to maintain. Also, there is an increasing proportion of investors who don’t want dividends, instead they want capital gains.
What is the dividend payout ratio? Can it be negative or greater than 100? When can this occur?
Dividend payout is dividends/net income, it is the percentage of earnings the company pays in dividends, if net income is negative, the payout ratio cannot be computed. This can even be larger than 100%, as a result of net income potentially being smaller than their cash flows, e.g due to large depreciation. This is common in large stable firms with small capital expenditure and large depreciation, allowing them to gradually liquidate themselves. It also could occur if a firm has a temporarily low net income and they don’t want to miss their dividend. Or if an unlevered firm wants to borrow more to increase their debt ratio they can use debt to pay a larger dividend.
What is the dividend yield?
Dividend yield is dividends per share/stock price. It measures the return an investor can make from dividends alone, making it part of the expected return on the investment.
How should the price change relate to the dividend and capital gains tax on the ex-dividend date?
(Pb-Pa)/Dividend = (1-dividend tax) / (1- capital gains tax).
Hence, if dividends and capital gains are evenly taxed the price change should equal the dividend, if dividends are taxed at a higher rate than capital gains the price change should be less than the dividend, if the dividends are taxed at a lower rate than capital gains the price change should be more than the dividend.
what signal does a dividend send to the market?
Dividends also send a signal to the market that the company is doing well, increases in dividends are good news, decreases are bad news. However, a too high or new dividend may signal that a company has ran out of good growth opportunities. However, in recent years a decrease or increase in dividends has been less informative than it used to be.
What do we do in peer group analysis of dividends?
In peer group analysis of dividends we try to take a dividend policy similar to peer firms.
Why might a firm not cancel its dividend?
If a firm has previously paid high dividends it will lead to investors which love high dividends, lowering this dividend in the short term will make them unhappy, leading to a share price drop as they sell. However, this may be the correct call in the long run, particularly If they announce investment or growth opportunities.
Why should high growth firms not initiate dividends?
High growth firms should not initiate dividends because if they attract investors that love dividends they will lose more rational investors, offsetting the gain from increasing their stockholder base.
