measures of dividend policy - new york university...

154

MeasuresofDividendPolicy

Aswath Damodaran

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¨ DividendPayout=Dividends/NetIncome¤ Measuresthepercentageofearningsthatthecompanypaysindividends

¤ Ifthenetincomeisnegative,thepayoutratiocannotbecomputed.

¨ DividendYield=Dividendspershare/Stockprice¤ Measuresthereturnthataninvestorcanmakefromdividendsalone

¤ Becomespartoftheexpectedreturnontheinvestment.

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DividendPayoutRatio:January2017

Aswath Damodaran

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0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

<10% 10-20% 20-30% 30-40% 40-50% 50-60% 60-70% 70-80% 80-90% 90-100% >100%

PayoutRatiosatthestartof2017:USandGlobalFirms

US Global

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DividendYields:January2017

Aswath Damodaran

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0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

<.5% .5-1% 1-1.5% 1.5-2% 2-2.5% 2.5-3% 3-3.5% 3.5-4% 4-4.5% 4.5-5% 5-5.5% 5.5-6% 6-6.5% 6.5-7% 7-7.5% 7.5-8% >8%

DividendYieldsatthestartof2017:US&Global

US Global

75thPerc. BroadGroup 25thPerc. Median 75thPerc.Australia,NZandCanada 1.77% 3.39% 5.09%DevelopedEurope 1.62% 2.84% 4.68%EmergingMarkets 0.88% 2.27% 4.62%Japan 1.33% 2.08% 2.81%UnitedStates 1.17% 2.12% 3.47%

Aswath Damodaran157

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DividendYieldsandPayoutRatios:GrowthClasses

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0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

0-3% 3-5% 5-10% 10-15% 15-20% 20-25% >25%

DividendYieldsandPayoutRatios:ByGrowthClass

DividendPayoutratio

DividendYield

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DividendPolicy:Disney,Vale,TataMotors,Baidu andDeutscheBank

Aswath Damodaran

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Disney Vale Tata Motors Baidu Deutsche Bank Dividend Yield - Last 12 months 1.09% 6.56% 1.31% 0.00% 1.96% Dividend Payout ratio - Last 12 months 21.58% 113.45% 16.09% 0.00% 362.63% Dividend Yield - 2008-2012 1.17% 4.01% 1.82% 0.00% 3.14% Dividend Payout - 2008-2012 17.11% 37.69% 15.53% 0.00% 37.39%

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ThreeSchoolsOfThoughtOnDividends

1. Iftherearenotaxdisadvantagesassociatedwithdividends& companiescanissuestock,atnoissuancecost,toraiseequity,wheneverneeded

Dividendsdonotmatter,anddividendpolicydoesnotaffectvalue.

2. Ifdividendscreateataxdisadvantageforinvestors(relativetocapitalgains)

Dividendsarebad,andincreasingdividendswillreducevalue3. Ifdividendscreateataxadvantageforinvestors

(relativetocapitalgains)and/orstockholderslikedividends

Dividendsaregood,andincreasingdividendswillincreasevalue

Aswath Damodaran

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Thebalancedviewpoint

Aswath Damodaran

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¨ Ifacompanyhasexcesscash,andfewgoodinvestmentopportunities(NPV>0),returningmoneytostockholders(dividendsorstockrepurchases)isgood.

¨ Ifacompanydoesnothaveexcesscash,and/orhasseveralgoodinvestmentopportunities(NPV>0),returningmoneytostockholders(dividendsorstockrepurchases)isbad.

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TheDividendsdon’tmatterschoolTheMillerModiglianiHypothesis

Aswath Damodaran

162

¨ TheMiller-ModiglianiHypothesis:Dividendsdonotaffectvalue¨ Basis:

¤ Ifafirm'sinvestmentpolicies(andhencecashflows)don'tchange,thevalueofthefirmcannotchangeasitchangesdividends.

¤ Ifafirmpaysmoreindividends,itwillhavetoissuenewequitytofundthesameprojects.Bydoingso,itwillreduceexpectedpriceappreciationonthestockbutitwillbeoffsetbyahigherdividendyield.

¤ Ifweignorepersonaltaxes,investorshavetobeindifferenttoreceivingeitherdividendsorcapitalgains.

¨ UnderlyingAssumptions:(a)Therearenotaxdifferencestoinvestorsbetweendividendsandcapitalgains.(b)Ifcompaniespaytoomuchincash,theycanissuenewstock,withnoflotationcostsorsignalingconsequences,toreplacethiscash.(c)Ifcompaniespaytoolittleindividends,theydonotusetheexcesscashforbadprojectsoracquisitions.

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II.TheDividendsare“bad” school:Andtheevidencetobackthemup…

Aswath Damodaran

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0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

191619181920192219241926192819301932193419361938194019421944194619481950195219541956195819601962196419661968197019721974197619781980198219841986198819901992199419961998200020022004200620082010201120132015

Figure10.10:TaxratesonDividendsandCapitalGains- US

Dividendtaxrate Capitalgainstaxrate

Difference betweendividendtaxrate&capitalgainspeaksat66%in1950s.

Dividends&capital gainstaxedatsameratesince2003.

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Whatdoinvestorsinyourstockthinkaboutdividends?Cluesontheex-dividendday!

Aswath Damodaran

164

¨ Assumethatyouaretheownerofastockthatisapproachinganex-dividenddayandyouknowthatdollardividendwithcertainty.Inaddition,assumethatyouhaveownedthestockforseveralyears.

P=Priceatwhichyouboughtthestocka“while” backPb=Pricebeforethestockgoesex-dividendPa=Priceafterthestockgoesex-dividendD=Dividendsdeclaredonstockto,tcg =Taxespaidonordinaryincomeandcapitalgainsrespectively

Ex-dividend day

Dividend = $ D

Initial buyAt $P

Pb Pa

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CashflowsfromSellingaroundEx-DividendDay

Aswath Damodaran

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¨ Thecashflowsfromsellingbeforeex-dividenddayare:Pb - (Pb - P)tcg

¨ Thecashflowsfromsellingafterex-dividenddayare:Pa - (Pa - P)tcg +D(1-to)

¨ Sincetheaverageinvestorshouldbeindifferentbetweensellingbeforetheex-dividenddayandsellingaftertheex-dividendday-Pb - (Pb - P)tcg =Pa - (Pa - P)tcg +D(1-to)

¨ Somebasicalgebraleadsustothefollowing:

€

Pb −PaD

=1− to1− tcg

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IntuitiveImplications

Aswath Damodaran

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¨ Therelationshipbetweenthepricechangeontheex-dividenddayandthedollardividendwillbedeterminedbythedifferencebetweenthetaxrateondividendsandthetaxrateoncapitalgainsforthetypicalinvestorinthestock.

Tax Rates Ex-dividend day behavior

If dividends and capital gains are taxed equally

Price change = Dividend

If dividends are taxed at a higher rate than capital gains

Price change < Dividend

If dividends are taxed at a lower rate than capital gains

Price change > Dividend

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Theempiricalevidence…

Aswath Damodaran

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•Ordinarytaxrate=70%•Capitalgainsrate=28%•Pricechangeas%ofDividend=78%

1966-1969

•Ordinarytaxrate=50%•Capitalgainsrate=20%•Pricechangeas%ofDividend=85%

1981-1985

•Ordinarytaxrate=28%•Capitalgainsrate=28%•Pricechangeas%ofDividend=90%

1986-1990

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DividendArbitrage

Aswath Damodaran

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¨ Assumethatyouareataxexemptinvestor,andthatyouknowthatthepricedropontheex-dividenddayisonly90%ofthedividend.Howwouldyouexploitthisdifferential?a. Investinthestockforthelongtermb. Sellshortthedaybeforetheex-dividendday,buyonthe

ex-dividenddayc. Buyjustbeforetheex-dividendday,andsellafter.d. ______________________________________________

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Exampleofdividendcapturestrategywithtaxfactors

Aswath Damodaran

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¨ XYZcompanyissellingfor$50atcloseoftradingMay3.OnMay4,XYZgoesex-dividend;thedividendamountis$1.Thepricedrop(frompastexaminationofthedata)isonly90%ofthedividendamount.

¨ Thetransactionsneededbyatax-exemptU.S.pensionfundforthearbitrageareasfollows:¤ 1.Buy1millionsharesofXYZstockcum-dividendat$50/share.¤ 2.Waittillstockgoesex-dividend;Sellstockfor$49.10/share(50- 1*0.90)

¤ 3.Collectdividendonstock.¨ Netprofit=- 50million+49.10million+1million=$0.10million

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Twobadreasonsforpayingdividends1.Thebirdinthehandfallacy

Aswath Damodaran

170

¨ Argument:Dividendsnowaremorecertainthancapitalgainslater.Hencedividendsaremorevaluablethancapitalgains.Stocksthatpaydividendswillthereforebemorehighlyvaluedthanstocksthatdonot.

¨ Counter:Theappropriatecomparisonshouldbebetweendividendstodayandpriceappreciationtoday.Thestockpricedropsontheex-dividendday.

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2.Wehaveexcesscashthisyear…

Aswath Damodaran

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¨ Argument:Thefirmhasexcesscashonitshandsthisyear,noinvestmentprojectsthisyearandwantstogivethemoneybacktostockholders.

¨ Counter:Sowhynotjustrepurchasestock?Ifthisisaone-timephenomenon,thefirmhastoconsiderfuturefinancingneeds.Thecostofraisingnewfinancinginfutureyears,especiallybyissuingnewequity,canbestaggering.

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TheCostofRaisingCapital

Aswath Damodaran

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0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Under $1 mil $1.0-1.9 mil $2.0-4.9 mil $5.0-$9.9 mil $10-19.9 mil $20-49.9 mil $50 mil and over

Cost

as %

of f

unds

raise

d

Size of Issue

Figure 10.12: Issuance Costs for Stocks and Bonds

Cost of Issuing bonds Cost of Issuing Common Stock

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Three“good” reasonsforpayingdividends…

Aswath Damodaran

173

¨ ClienteleEffect:Theinvestorsinyourcompanylikedividends.

¨ TheSignallingStory:Dividendscanbesignalstothemarketthatyoubelievethatyouhavegoodcashflowprospectsinthefuture.

¨ TheWealthAppropriationStory:Dividendsareonewayoftransferringwealthfromlenderstoequityinvestors(thisisgoodforequityinvestorsbutbadforlenders)

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1.TheClienteleEffectThe“strangecase” ofCitizen’sUtility

Aswath Damodaran

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Class A shares pay cash dividend

Class B shares offer the same amount as a stock dividend & can be converted to class A shares

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EvidencefromCanadianfirms

Aswath Damodaran

175

Company Premium for cash dividend sharesConsolidated Bathurst + 19.30%Donfasco + 13.30%Dome Petroleum + 0.30%Imperial Oil +12.10% Newfoundland Light & Power + 1.80%Royal Trustco + 17.30%Stelco + 2.70%TransAlta +1.10%Average across companies + 7.54%

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Aclientelebasedexplanation

Aswath Damodaran

176

¨ Basis:Investorsmayformclientelesbasedupontheirtaxbrackets.Investorsinhightaxbracketsmayinvestinstockswhichdonotpaydividendsandthoseinlowtaxbracketsmayinvestindividendpayingstocks.

¨ Evidence:Astudyof914investors'portfolioswascarriedouttoseeiftheirportfoliopositionswereaffectedbytheirtaxbrackets.Thestudyfoundthat¤ (a)Olderinvestorsweremorelikelytoholdhighdividendstocksand

¤ (b)Poorerinvestorstendedtoholdhighdividendstocks

ResultsfromRegression:ClienteleEffect

DividendYieldt= a+ bbt+ c Aget+ d Incomet+ eDifferential Tax Ratet+et

Variable Coefficient Implies

Constant 4.22%

BetaCoefficient -2.145 Higher betastocks pay lower dividends.

Age/100 3.131 Firms witholder investors pay higher

dividends.

Income/1000 -3.726 Firms withwealthier investors pay lower

dividends.

Differential Tax Rate -2.849 If ordinary incomeis taxedatahigher rate

thancapital gains, thefirmpays less

dividends.

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DividendPolicyandClientele

Aswath Damodaran

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¨ Assumethatyourunaphonecompany,andthatyouhavehistoricallypaidlargedividends.Youarenowplanningtoenterthetelecommunicationsandmediamarkets.Whichofthefollowingpathsareyoumostlikelytofollow?

a. Courageouslyannouncetoyourstockholdersthatyouplantocutdividendsandinvestinthenewmarkets.

b. Continuetopaythedividendsthatyouusedto,anddeferinvestmentinthenewmarkets.

c. Continuetopaythedividendsthatyouusedto,maketheinvestmentsinthenewmarkets,andissuenewstocktocovertheshortfall

d. Other

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2.Dividendssendasignal”Increasesindividendsaregoodnews..

Aswath Damodaran

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Buthigherornewdividendsmaysignalbadnews(notgood)

Aswath Damodaran

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0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

-4 -3 -2 -1 1 2 3 4

Annu

alEarningsG

rowthRate

Yearrelativetodividendinitiation(Beforeandafter)

DividendInitiationsandEarningsGrowth

Bothdividendincreasesanddecreasesarebecominglessinformative…

-6.00%

-5.00%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

1962-1974 1975-1987 1988-2000

Market Reaction to Dividend Changes over time: US companies

DividendIncreases

DividendDecreases

3.Dividendincreasesmaybegoodforstocks…butbadforbonds..

-2

-1.5

-1

-0.5

0

0.5

t:-15

-12 -9 -6 -3 0 3 6 9 12 15

CAR (Div Up)

CAR (Div down)

EXCESS RETURNS ON STOCKS AND BONDS AROUND DIVIDEND CHANGES

Day (0: Announcement date)

CAR

Bond price drops

Stock price rises

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Whatmanagersbelieveaboutdividends…

Aswath Damodaran

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ASSESSINGDIVIDENDPOLICY:ORHOWMUCHCASHISTOOMUCH?

ItismycashandIwantitnow…

Aswath Damodaran 184

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TheBigPicture…

Aswath Damodaran

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The Investment DecisionInvest in assets that earn a

return greater than the minimum acceptable hurdle

rate

The Financing DecisionFind the right kind of debt for your firm and the right mix of debt and equity to

fund your operations

The Dividend DecisionIf you cannot find investments

that make your minimum acceptable rate, return the cash

to owners of your business

The hurdle rate should reflect the riskiness of the investment and the mix of debt and equity used

to fund it.

The return should reflect the magnitude and the timing of the

cashflows as well as all side effects.

The optimal mix of debt and equity

maximizes firm value

The right kind of debt

matches the tenor of your

assets

How much cash you can

return depends upon

current & potential

investment opportunities

How you choose to return cash to the owners will

depend on whether they

prefer dividends or buybacks

Maximize the value of the business (firm)

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AssessingDividendPolicy

Aswath Damodaran

186

¨ Approach1:TheCash/TrustNexus¤ Assesshowmuchcashafirmhasavailabletopayindividends,relativewhatitreturnstostockholders.Evaluatewhetheryoucantrustthemanagersofthecompanyascustodiansofyourcash.

¨ Approach2:PeerGroupAnalysis¤ Pickadividendpolicyforyourcompanythatmakesitcomparabletootherfirmsinitspeergroup.

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I.TheCash/TrustAssessment

Aswath Damodaran

187

Step1:Howmuchdidthethecompanyactuallypayoutduringtheperiodinquestion?Step2:Howmuchcouldthecompanyhavepaidoutduringtheperiodunderquestion?Step3:HowmuchdoItrustthemanagementofthiscompanywithexcesscash?

¤ Howwelldidtheymakeinvestmentsduringtheperiodinquestion?

¤ Howwellhasmystockperformedduringtheperiodinquestion?

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Howmuchhasthecompanyreturnedtostockholders?

Aswath Damodaran

188

¨ Asfirmsincreasingusestockbuybacks,wehavetomeasurecashreturnedtostockholdersasnotonlydividendsbutalsobuybacks.

¨ Forinstance,forthefivecompaniesweareanalyzingthecashreturnedlookedasfollows.

Disney Vale TataMotors Baidu DeutscheBankYear Dividends Buybacks Dividends Buybacks Dividends Buybacks Dividends Buybacks Dividends Buybacks2008 $648 $648 $2,993 $741 7,595₹ 0₹ ¥0 ¥0 2,274€ 0€2009 $653 $2,669 $2,771 $9 3,496₹ 0₹ ¥0 ¥0 309€ 0€2010 $756 $4,993 $3,037 $1,930 10,195₹ 0₹ ¥0 ¥0 465€ 0€2011 $1,076 $3,015 $9,062 $3,051 15,031₹ 0₹ ¥0 ¥0 691€ 0€2012 $1,324 $4,087 $6,006 $0 15,088₹ 970₹ ¥0 ¥0 689€ 0€

2008-12 $4,457 $15,412 $23,869 $5,731 51,405₹ 970₹ ¥0 ¥0 ¥4,428 ¥0

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AMeasureofHowMuchaCompanyCouldhaveAffordedtoPayout:FCFE

Aswath Damodaran

189

¨ TheFreeCashflowtoEquity(FCFE)isameasureofhowmuchcashisleftinthebusinessafternon-equityclaimholders(debtandpreferredstock)havebeenpaid,andafteranyreinvestmentneededtosustainthefirm’sassetsandfuturegrowth.

NetIncome+Depreciation&Amortization=CashflowsfromOperationstoEquityInvestors- PreferredDividends- CapitalExpenditures- WorkingCapitalNeeds=FCFEbeforenetdebtcashflow(Owner’sEarnings)+NewDebtIssues- DebtRepayments=FCFEafternetdebtcashflow