measures of dividend policy - new york university...
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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
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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
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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%
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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
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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
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Thebalancedviewpoint
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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
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¨ 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…
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0.00%
10.00%
20.00%
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60.00%
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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!
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¨ 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
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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
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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…
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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
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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
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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
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¨ Argument:Dividendsnowaremorecertainthancapitalgainslater.Hencedividendsaremorevaluablethancapitalgains.Stocksthatpaydividendswillthereforebemorehighlyvaluedthanstocksthatdonot.
¨ Counter:Theappropriatecomparisonshouldbebetweendividendstodayandpriceappreciationtoday.Thestockpricedropsontheex-dividendday.
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2.Wehaveexcesscashthisyear…
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¨ Argument:Thefirmhasexcesscashonitshandsthisyear,noinvestmentprojectsthisyearandwantstogivethemoneybacktostockholders.
¨ Counter:Sowhynotjustrepurchasestock?Ifthisisaone-timephenomenon,thefirmhastoconsiderfuturefinancingneeds.Thecostofraisingnewfinancinginfutureyears,especiallybyissuingnewequity,canbestaggering.
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TheCostofRaisingCapital
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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…
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¨ ClienteleEffect:Theinvestorsinyourcompanylikedividends.
¨ TheSignallingStory:Dividendscanbesignalstothemarketthatyoubelievethatyouhavegoodcashflowprospectsinthefuture.
¨ TheWealthAppropriationStory:Dividendsareonewayoftransferringwealthfromlenderstoequityinvestors(thisisgoodforequityinvestorsbutbadforlenders)
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1.TheClienteleEffectThe“strangecase” ofCitizen’sUtility
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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
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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
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¨ 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
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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..
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Buthigherornewdividendsmaysignalbadnews(notgood)
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0.00%
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-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…
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ASSESSINGDIVIDENDPOLICY:ORHOWMUCHCASHISTOOMUCH?
ItismycashandIwantitnow…
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TheBigPicture…
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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
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¨ Approach1:TheCash/TrustNexus¤ Assesshowmuchcashafirmhasavailabletopayindividends,relativewhatitreturnstostockholders.Evaluatewhetheryoucantrustthemanagersofthecompanyascustodiansofyourcash.
¨ Approach2:PeerGroupAnalysis¤ Pickadividendpolicyforyourcompanythatmakesitcomparabletootherfirmsinitspeergroup.
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I.TheCash/TrustAssessment
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Step1:Howmuchdidthethecompanyactuallypayoutduringtheperiodinquestion?Step2:Howmuchcouldthecompanyhavepaidoutduringtheperiodunderquestion?Step3:HowmuchdoItrustthemanagementofthiscompanywithexcesscash?
¤ Howwelldidtheymakeinvestmentsduringtheperiodinquestion?
¤ Howwellhasmystockperformedduringtheperiodinquestion?
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Howmuchhasthecompanyreturnedtostockholders?
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¨ 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
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¨ TheFreeCashflowtoEquity(FCFE)isameasureofhowmuchcashisleftinthebusinessafternon-equityclaimholders(debtandpreferredstock)havebeenpaid,andafteranyreinvestmentneededtosustainthefirm’sassetsandfuturegrowth.
NetIncome+Depreciation&Amortization=CashflowsfromOperationstoEquityInvestors- PreferredDividends- CapitalExpenditures- WorkingCapitalNeeds=FCFEbeforenetdebtcashflow(Owner’sEarnings)+NewDebtIssues- DebtRepayments=FCFEafternetdebtcashflow