Examination of 3 forms of a Stable Dividend Policy

These examination requires addressing the following questions: 2. What is their relative suitability ? 3. What are their implication to the shareholders & the firm ? 4. Which form would find favour with the investors ?

Constant Payout Ratio guards against overpayment as well as underpayment of dividends because management can not pay dividends if there are no profits & it can not withhold them when profits are earned. From the shareholder’s view point, this method involves uncertainty & irregularity in regard to the expected dividends. Stable Rupee Dividend Plus Extra Dividend is suitable for companies whose earnings fluctuate widely. From the investor’s view point, the extra dividend is of sporadic nature.

Constant Dividend Per Share gives an assured fixed amount as dividends which has gradually & consistently increase over the years.

Why should a firm follow stable dividend policy ?
Various reasons are as follow:-:6. Desire for current income 7. Informational Contents 8. Requirements of Institutional Investors

# A company should seek stable dividend policy which avoids occasional reduction of dividends. Investors favourably react to the price of shares of such companies & there is a price enhancing effect of such policy as it resolves the uncertainty from the minds of the investors regarding the anticipated stream of dividends.

EXAMPLE
X & Y ARE TWO FAST GROWING COMPANIES IN THE ENGINEERING INDUSTRY. THEY ARE CLOSE COMPITITORS & THEIR ASSETS COMPOSITION, CAPITAL STRUCTURE & PROFITABILITY RECORDS HAVE BEEN VERY SIMILAR FOR SEVERAL YEARS. THE PRIMARY DIFFERENCE BETWEEN THEM FROM FINANCIAL MANAGEMENT PERSPECTIVE IS THEIR DIVIDEND POLICY THE COMPANY X TRIES . TO MAINTAIN A NON DECREASING DIVIDEND PER SHARE, WHILE THE COMPANY Y MAINTAINS A CONSTANT DIVIDEND PAY OUT RATIO. THEIR RECENT EARNING PER SHARE(EPS), DIVIDEND PER SHARE (DPS), & SHARE PRICE (P) HISTORY ARE AS FOLLOWS:::::

Year EPS 1 2 3 4 5 6 7 Rs 9.30 7.40 10.50 12.75 20.00 16.00 19.00

COMPANY X DPS P(RANGE) EPS Rs 2 2 2 2.25 2.50 2.50 2.50 Rs 75-90 55-80 70-110 85-135 135-200 150-190 155-210 Rs 9.50 7.00 10.50 12.25 20.25 17.00 20.00

COMPANY Y DPS P(RANGE ) Rs 1.90 1.40 2.10 2.45 4.05 3.40 4.00 Rs 60-80 25-65 35-80 80-120 110-225 140-180 130-190

QUESTIONS OF EXAMPLE
IN ALL CALCULATIONS BELOW THAT REQUIRE A SHARE PRICE, USE THE AVERAGE OF THE TWO PRICES GIVEN IN THE SHARE PRICE RANGE. (A) DETERMINE THE DIVIDEND PAYOUT RATIO (D/P) & PRICE TO EARNINGS(P/E) RATIO FOR BOTH COMPANIES FOR ALL THE YEARS. (B) DETERMINE THE AVERAGE D/P & P/E FOR BOTH THE COMPANIES OVER THE PERIOD 1 THROUGH 7. (C) THE MANAGEMENT OF COMPANY Y IS PUZZLED AS TO WHY THEIR SHARE PRICES ARE LOWER THAN THOSE OF COMPANY X, IN SPITE OF THE BETTER PROFITABILITY RECORD PARTICULARLY OF THE PAST 3 YEARS. AS A FINANCIAL CONSULTANT, HOW WOULD YOU EXPLAIN THE SITUATION ?????????

SOLUTION
(A) & (B)

D D/P & P/E RATIOS COMPANY X COMPANY Y P/E RATIO 8.87 9.12 8.57 8.63 8.37 10.62 9.6 9.16 EPS 9.50 7.00 10.5 0 12.2 5 20.2 5 17.0 0 20.0 0 96.5 0 DPS 1.90 1.40 2.10 2.45 4.05 3.40 4.00 D/P RATI O 20 20 20 20 20 20 20 P 70 45 57.50 100.0 0 167.5 0 160.0 0 160.0 0 760.0 0 P/E RATIO 7.37 6.43 5.48 8.16 8.27 9.41 8.00 7.88 DPS 2.00 2.00 D/P RATI O 21.5 27.5 19.0 17.6 12.5 15.6 13.2 16.6 P 82.50 67.50 90.00 110.0 0 167.5 0 170.0 0 182.5 0 870.0 0

YE AR 1 2 3 4 5 6 7

EPS 9.30 7.40

10.50 2.00 12.75 2.25 20.00 2.50 16.00 2.50 19.00 2.50 94.95 15.7 5

19.30 20

(c) COMPANY X IS FOLLOWING A STABLE DIVIDEND POLICY WHEREAS COMPANY Y IS FOLLOWING A STABLE DIVIDEND PAYOUT RATIO. IN THE LATTER TYPE OF POLICY, SPORADIC DIVIDEND PAYMENTS OCCUR WHICH MAKE ITS OWNERS VERY UNCERTAIN ABOUT THE RETURNS THEY CAN EXPECT FROM THEIR INVESTMENT IN THE FIRM &, THEREFORE, GENERALLY DEPRESS THE SHARE PRICES. IT IS PROBABLY FOR THIS REASON THAT THE COMPANY X’S AVERAGE PRICE PER SHARE EXHIBITED A CONSISTENT INCREASE COMPARED TO COMPANY Y, VOLATILE PATTERN OF EARNINGS OF BOTH COMPANIES (DURING THE LAST 3 YEARS) NOTWITHSTANDING. SO COMPANY Y IS ADVISED TO FOLLOW A STABLE DIVIDEND POLICY.