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Paying Back: Dividend Policy
Paying Back: Dividend Policy
POLICY
To Pay or Not to Pay?
Before deciding to pay the dividends or repurchase shares,
the manager asks a series of questions
Is the business generating enough positive free cash flow
after making all investments with positive NPVs?
Is the firm’s Debt ratio Prudent?
Are the company’s holding of cash a sufficient cushion for
unexpected setbacks and a sufficient war chest for
unexpected opportunities?
Measures of Dividend Policy
3
• Ex Dividend date
6/2/2018
• Share start to trade Ex-Dividend
• Record Date
• Dividend will be paid to shareholders registered till this
8/2/2018 date
• Payment Date
15/2/2018
• Dividend will be credited to shareholder
Empirical evidence about Cash Dividends
• Dividends are Sticky
• Dividends tend to follow earnings
• Dividends tend to follow smoother path than earnings
• Dividends follow life cycle
Figure 21.7: Life Cycle Analysis of Dividend Policy
Revenues
$ Revenues/
Earnings
Earnings
Years
External funding High, but High, relative Moderates, relative Low, as projects dry
Low, as projects dry
needs constrained by to firm value. to firm value. up.
up.
infrastructure
Internal financing Negative or Negative or Low, relative to High, relative to More than funding needs
low low funding needs funding needs
Source :A Damodaran
Dividend Policy
Survey 2004
Information Content of Dividend and Repurchases
• Payout Decision
• Managers are reluctant to make dividend changes that
may be reversed
• Dividend change
• Stock Splits
• Issue of additional shares to firm’s stockholders
• Buyback
• Firm buys back stock from its shareholders
Stock Split
• Stock splits are akin to optical illusions – they give the
impression that things have changed. In reality, splits are
only adjustments in the number of shares outstanding,
while the company's equity and the value of shareholders'
holdings remain unchanged.
• Although most investors view stock splits as inherently
bullish, do not be swayed by this fact alone. The effects of
stocks splits are only temporary in nature. Ultimately, the
company's business fundamentals will be the true drivers
of the stock's value and its future direction.
What's the Point of a Stock Split?
• Psychology:: Splitting the stock brings the share price
down to a more "attractive" level. The effect here is purely
psychological
• Increase Liquidity
Three Schools Of Thought On Dividends
Initial buy Pb Pa
At P
Ex-dividend day
Dividend = D
P = Price at which you bought the stock a “while” back
Pb= Price before the stock goes ex-dividend
Pa=Price after the stock goes ex-dividend
D = Dividends declared on stock
to, tcg = Taxes paid on ordinary income and capital gains respectively
Cashflows from Selling around Ex-Dividend Day
23
Pb - Pa 1- t o
=
D 1- t cg
Intuitive Implications
24
1966-1969
1981-1985
1986-1990
• Assume that you are a tax exempt investor, and that you
know that the price drop on the ex-dividend day is only
90% of the dividend. How would you exploit this
differential?
a. Invest in the stock for the long term
b. Sell short the day before the ex-dividend day, buy on the ex-
dividend day
c. Buy just before the ex-dividend day, and sell after.
d. ______________________________________________
Example of dividend capture strategy with tax
factors
27
35.00%
Annual Earnings Growth Rate
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
-4 -3 -2 -1 1 2 3 4
Year relative to dividend initiation (Before and after)