Applied Corporate Finance. Unit 5

Transcription

1 Applied Corporate Finance Unit 5

2 Dividend Policy Measures Yield, Payout and Dividend Rate Determinants of Dividend Policy Various schools of though on Dividend Policy Managing Changes in Dividend Policy

3 First Principles Maximize the value of the business (firm) The Investment Decision Invest in assets that earn a return greater than the minimum acceptable hurdle rate The Financing Decision Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations The Dividend Decision If 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 welll 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 Source: Applied Corporate Finance, Aswath Damodaran

4 What is Dividend When a firm makes profits, it can choose to either retain those within the company as source of funds, or return it to equity holders. When the money is returned to the equity holders, this is known as a Dividend. Dividend policy is thus a very important part of a company s corporate finance decision making, and investor preferences for a company change based on its dividend policy.

5 Dividend Characteristics It has been seen that Dividends tend to be sticky which means that companies usually would not cut dividends unless the financial situation is really bad Dividends tend to follow the earnings, which is logical since from earnings the dividends will get paid Dividends get impacted by taxation laws for dividends. Tax laws are important, else the promoter would take all money out in the form of dividends if there was no tax. Dividend also depends on the maturity of the country s economy.

6 Dividend Yields across countries Source:

7 Dividend Common Terms Dividends can be measured in 3 ways Dividend Rate Dividend Payout Dividend Yield

8 Dividend Common Terms Dividends can be measured in 3 ways Dividend Rate Companies usually use this method to announce the dividend they are paying. This dividend is as a percentage of the face value of the company s stock.

9 Dividend Common Terms Dividend Payout We can calculate what is the payout ratio by dividing the dividend amount with the profits. This is the percentage of profits being paid out. Subtracting this from 1 will give us the retention ratio. Year Consolidated Profit 1, , Equity Share Dividend Tax On Dividend Total spend on Dividend Divident Payout Ratio 11.91% 12.53% 4.40% 4.81% 7.15% Divident Payout Ratio (Excluding Dividend Tax) 9.31% 10.41% 3.76% 4.11% 6.15%

10 Dividend Common Terms Dividend Yield We can calculate this by dividing the company s dividend with the market price. In a way, this is the actual return the investor makes in the form of dividends, and as a shareholder, you should be most concerned about this in the measures of dividend.

11 Companies can declare dividend either during the year (known as Interim Dividend) or at the end of the year (known as Final Dividend). These are combined during the year to understand the total dividend for the year. Dividend Interim and Final

12 Dividend Payout BSE 100 companies Source:

13 Sample question A company has a face value of Rs 10, dividend rate of 50%, shares outstanding at 20 crore, profits at Rs 400 crore, and a share price of Rs 200. What is the dividend yield, dividend rate, and dividend payout ratio?

14 Questions What are the key characteristics of dividend? A company has a face value of Rs 10, dividend rate of 30%, shares outstanding at 10 crore, profits at Rs 200 crore, and a share price of Rs 100. What is the dividend yield, dividend rate, and dividend payout ratio?

15 Applied Corporate Finance Unit 5

16 Schools of thought on Dividend Policy There are 3 schools of thought on dividends Dividends do not matter Dividends are bad Dividends are good

17 Dividends do not matter This is also known as the Miller Modigliani Hypothesis. It makes a few assumptions There is no cost direct or indirect of new stock issuance There is no difference between the tax treatment for capital gains and dividends The companies do not destroy value of unpaid dividend by investing in bad projects If there are no tax disadvantages associated with dividends & companies can issue stock, at no issuance cost, to raise equity, whenever needed, then the investor should be indifferent to getting paid in dividends or via capital appreciation.

18 Dividends are bad If the dividends create a disadvantage for investors due to taxation treatment, then they can be considered bad. Also, sometimes dividends show that the company is not finding enough projects that can make money, and that may result in profits stagnating and share price not performing.

19 Dividends are bad Year Consolidated Profit 3,080 3,193 1,968 1, Equity Share Dividend

20 Dividends are good Most of the times though, dividends are good news Investors are happy about dividends Most of the times, it is about the company signaling good future ahead, since companies are not expected to reduce dividend payouts. Dividends are a way of transferring wealth from lenders to equity holders.

21 Some incorrect reasons to pay dividends While dividend payment are generally considered good, sometimes it does not make sense to increase dividend payments. A couple of such situations are Company has too much cash, but this is a temporary phenomenon Since dividends are sticky, it may make sense to do a buyback, instead of a dividend. Some companies use this to issue a special dividend. Dividends are more certain, and are better than future capital appreciation Here, we are inherently assuming that the company may destroy value with this money in future. Sometimes, companies may be making losses but still paying dividends. This could be because promoters want money. Examples would be Public Sector firms, whose dividend is a source of income for the government.

22 Special Dividend

23 Special Dividend

24 Questions Explain the assumptions inherent in the Dividends do not matter school. What is a special dividend?

25 Applied Corporate Finance Unit 5

26 Assessing the company s dividend policy In assessing any company s dividend policy, it is important to understand two things 1. We should find out how much dividend the company paid, and how much it could have paid. If we find they are paying less as compared to what they should, then we try and gauge if they are creating value by investing that money in good projects. 2. We should find if the company is paying enough when compared to its peers.

27 What did the company pay? To understand this, we need to find out how much dividend the company paid, and how much buyback did it do. We have to add the two to get to this value. It may also make sense to view this over a period of multiple years, since buybacks may not happen every year.

28 What could they have paid the FCFE A measure of what the company could have paid as dividend is the Free Cash Flow to Equity. The FCFE is the measure of how much cash is left in the business after taking care of the non-equity payments (Debt) and reinvestment needed for future growth Capex and Working Capital investments.

29 What could they have paid the FCFE A measure of what the company could have paid as dividend is the Free Cash Flow to Equity. The FCFE is the measure of how much cash is left in the business after taking care of the non-equity payments (Debt) and reinvestment needed for future growth Capex and Working Capital investments. FCFE = Net Profit + Depreciation and Amortization - Capital Expenditure - Working Capital Changes - Debt Repayments + Debts Raised

30 Apollo Tyres Dividend Analysis Let s now check this for Apollo Tyres

31 ROE vs Cost of Equity Let us also try and calculate the Return on Equity vs the Cost of Equity for Apollo Tyres, which will give us an idea if they have indeed created value from the money they did not pay to investors.

32 Similar test for Your Company Try and do the same for your company under the project 1. Calculate FCFE for the last few years 2. Calculate the Dividend Paid and Buybacks over those years 3. Compare ROE vs Cost of Equity for the period under consideration, to see if the company has created value with undistributed dividends, if any

33 Questions What number tells us about the potential of a firm to pay dividend? How do we calculate it? Should buybacks be also considered as a dividend payment? Why?

34 Applied Corporate Finance Unit 5

35 Assessing the company s dividend policy In assessing any company s dividend policy, it is important to understand two things 1. We should find out how much dividend the company paid, and how much it could have paid. If we find they are paying less as compared to what they should, then we try and gauge if they are creating value by investing that money in good projects. 2. We should find if the company is paying enough when compared to its peers.

36 What about peers? Let us also look at MRF and Ceat Tyres over the last year. Let us calculate FCFE for them over the last year, and try and check what dividend they have paid.

37 Questions What would your views be about the Dividend Policy of Apollo Tyres vs its peers?

38 Applied Corporate Finance Unit 5

39 Stock Dividend / Bonus Assume that the company gives a stock dividend of 1 share for every 1 share held Now Shares Outstanding 10,00,000 EPS 10 Net Profit 1,00,00,000 Stock Price 200 Market Cap 20,00,00,000 Face Value 10 Share Capital 1,00,00,000 Reserves and Surplus 5,00,00,000 P/E 20 Dividend 30% Dividend per share 3 Dividend Yield 1.5% After Bonus 20,00, ,00,00, ,00,00, ,00,00,000 4,00,00, % 3 3%

40 Why Stock Dividend? So why would companies give stock dividends? In general, this increases the investor base over a period of time All else being equal, lower share price results in attracting more investors It is a cashless transaction, but dividend payout increases Stock dividend does not disturb leverage ratios or solvency ratios

41 Bonus vs Split Now Shares Outstanding 10,00,000 EPS 10 Net Profit 1,00,00,000 Stock Price 200 Market Cap 20,00,00,000 Face Value 10 Share Capital 1,00,00,000 Reserves and Surplus 5,00,00,000 P/E 20 Dividend 30% Dividend per share 3 Dividend Yield 1.5% After Split 20,00, ,00,00, ,00,00, ,00,00,000 5,00,00, % % After Bonus 20,00, ,00,00, ,00,00, ,00,00,000 4,00,00, % 3 3%

42 Stock Bonuses Why investors like it? Companies that give stock bonuses are expected to give more bonuses in future. Usually the stock market expects that.

43 Stock Bonuses Why investors like it? Once a company gives a stock bonus, it is in a way specifying that it is doing well, and is expected to do well in the future as well. It can continue to pay the extra dividend.

44 Buybacks in India Off late, buybacks have increased in India. The reason is that the government has applied a new tax on any dividends in excess of Rs 10 lakhs. This has resulted in companies going for a buyback instead of paying dividends.

45 Dividend Policy Some Examples ITC Axis Bank BHEL

46 ITC

47 Axis Bank

48 BHEL

49 Dividend Policy - Summarizing The key determinants of dividend policy are thus Type of Industry Age of the Company Shareholder Distribution Reinvestment Needs Business Cycles Government Policies

50 Project work Try and look at your firm, and find out about the dividend policy of your firm in detail, just like we have done for Apollo Tyres

51 Questions Write down the key determinants of the dividend policy What is your expectation from a company s stock price, when the company has consistently increased dividend in the past, but has recently cut it down.