Getting Started…

FINC 5880Spring 2014

Scores FINC 5000

Option Strategy 14 March

• 1) Tiffany (1361%)• 2) Amazon (1090%)• 3) Ralph Lauren (67%)• 4) Nike (50%)• 5) Fedex (0%)• 6) Boeing (-44%)• 7) Apple (-61%)• 8) Google (-100%)

The Finance Framework

1) Dividends are sticky…

2) Dividends follow earnings…

3) Are effected by tax laws

4) More and more firms buy back shares instead of paying out dividends

5) There are differences between countries

Measures of Dividend Policy

• Dividend Payout = Dividends/ Net Income

• Measures the percentage of earnings that the company pays in dividends

• Note: If the net income is negative, the payout ratio cannot be computed.

• Dividend Yield = Dividends per share/ Stock price• Measures the return that an investor can make from

dividends alone• Becomes part of the expected return on the investment

Pay Out Ratios in the US (2010)

Dividend Yields in the US (2010)

Dividends and the life cycle of s business…

Ex dividend and Record dates

• As you can see by the diagram , if you buy on the ex-dividend date (Tuesday), which is only two business days before the date of record, you will not receive the dividend because your name will not appear in the company's record books until Friday. If you want to buy the stock and receive the dividend, you need to buy it on Monday. (When the stock is trading with the dividend the term cum dividend is used). But, if you want to sell the stock and still receive the dividend, you need to sell on or after Tuesday the 6th.

What do investors in your stock think about dividends? Clueson the ex-dividend day!

• Assume that you are the owner of a stock that is approaching an ex-dividend day and you know that dollar dividend with certainty. In addition, assume that you have owned the stock for several years.

• Let 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

Why the price of a stock drops on the ex dividend date with the amount of the dividend

• The cash flows from selling before the ex-dividend day are: Pb - (Pb - P) tcg

• The cash flows from selling after the ex-dividend day are: • Pa - (Pa - P) tcg + D(1-to)

• Since the average investor should be indifferent between selling before the ex dividend day and selling after the ex-dividend day

• Pb - (Pb - P) tcg = Pa - (Pa - P) tcg + D(1-to)• Some basic algebra leads us to the following:• (Pb-Pa)/D=(1-to)/(1-tcg)• So if to=tcg then the Price difference (before/after dividend) is

exactly equal to the dividend!• This is why we assume that Pa= Pb-D (the price after dividend is

price before dividend minus the dividend)

The balanced viewpoint

• If a company has excess cash, and few good investment opportunities (NPV>0), returning money to stockholders (dividends or stock repurchases) is good.

If a company does not have excess cash,

and/or has several good investment opportunities (NPV>0), returning money to stockholders (dividends or stock purchases) is bad.

Dividends are bad (tax perspective)

Dividends are good….but:Div Yield= a+b(Beta)+c(Age)+d(Income)+e(Tax diff)

Variable Coefficient Implies

Constant 4.22%

Beta Coefficient - 2.145 Higher Beta stocks pay lower dividends

Age/100 3.131 Firms with older investors pay more dividends

Income/1000 -3.726 Firms with higher income investors pay less dividends

Tax Differential - 2.849 If income is taxed at a higher rate than capital gains the firm pay less dividends

Dividends are good?

• Three “good” reasons for paying dividends…• 1. Clientele Effect: The investors in your company like

dividends.• 2. The Signaling Story: Dividends can be signals to the

market that you believe that you have good cash flow prospects in the future.

• 3. The Wealth Appropriation Story: Dividends are one way of transferring wealth from lenders to equity investors (this is good for equity investors but bad for lenders)

Dividend Matrix applied…

Peer Group analysis Disney…

Peer Group analysis Deutsche Bank

Going beyond averages… Looking at the market

• Regressing dividend yield and payout against expected growth across all US companies in January 2009 yields:

• PYT = Dividend Payout Ratio = Dividends/Net Income• YLD = Dividend Yield = Dividends/Current Price• ROE = Return on Equity• EGR = Expected growth rate in earnings over next 5 years (analyst

estimates)• STD = Standard deviation in equity values• INS = Insider holdings as a percent of outstanding stock

Applied to Disney…• To illustrate the applicability of the market regression in analyzing the• dividend policy of Disney, we estimate the values of the independent variables• in the regressions for the firm.• • Insider holdings at Disney (as % of outstanding stock) = 7.70%• • Standard Deviation in Disney stock prices = 19.30%• • Disney’s ROE = 13.05%• • Expected growth in earnings per share (Analyst estimates) = 14.50%

• Substituting into the regression equations for the dividend payout ratio and• dividend yield, we estimate a predicted payout ratio:• Predicted Payout = 0.683 – 0.185 (.1305) -1.07 (.1930) – 0.313 (.145) =0.4069• Predicted Yield = 0.039 – 0.039 (.1930) – 0.010 (.077) – 0.093 (.145) = .0172• Based on this analysis, Disney with its dividend yield of 1.67% and a payout• ratio of approximately 20% is paying too little in dividends. This analysis,• however, fails to factor in the huge stock buybacks made by Disney over the• last few years.

Week 1 Assignments:

• We made 5 statements about dividends test the first 4 for your company! Draw conclusions.

• Measure pay out ratio and dividend yield for your company over the last at least 10 years and compare with it’s peer group (what is your conclusion? Show your data)

• Where is your company in the dividend matrix? Conclude…

• We performed a market regression January 2009 and drew conclusions on Disney; do the same for your company (see example Disney)