The Dividend Payment in Companies - Essay Example

CASE STUDY 02 Table of Contents Table of Contents 2 Introduction 3 Dividend record of FPL Group Inc 3 Analysis of dividend payout ratio of peers 5 Peer Comparison 5 The customer mix of FPL Group comprises mainly of ‘residential’ whereas the share of its rivals in the sales to the ‘residential’ is quite low. The rivals of FPL have equally distributed their sales across “residential, commercial, industrial and utility companies.” But the sale of FPL is concentrated on residential and commercial. This shows that the customer mix of the company i.e. the percentage of sale to Industrial and Utility companies is very low at merely 8%. FPL Group can try and raise its sales to these two sections as this will enable the company to raise the revenues. The debt position of the company is more or less the same as that of its peers. 7 Anticipation of analysts 7 Dividend Irrelevance 8 Future Prospects of FPL Group 8 Conclusion 10 Reference 11 Introduction Dividend policy forms an integral part of corporate finance. It looks obvious that the company must reward its shareholders by declaring high dividends. But then the question is if the company declares all of its earnings as dividend merely to keep the shareholders happy then this will perhaps retard the future growth prospects. For this reason the companies do not declare all its earnings as dividend but they plough back a certain portion of the earnings in the form of ‘Retained Earnings’. The companies pay a lot of attention to ‘dividend policy’ as a fall may invite the wrath of the shareholders and a rise can come in the way of the growth prospects (Ross, et al., 2008, pp. 590). Dividend record of FPL Group Inc The dividend payment of FPL Group Inc has been on an upward move for the last ten years. In the year 1984 the company declared a dividend per share of $1.77 that reached the levels of $2.47 in 1993. Unlike the steady rise in the divided the earnings per share (EPS) of the company passed through fluctuations on many occasions but the impact of this was not felt on its dividend payment pattern. In fact in the year 1990 FPL Group incurred a net loss of $391.005 million resulting in a negative EPS of $2.86. But even in this year the company declared a dividend of $2.34. The main incentive of a share issue is that payment of dividend is ‘not obligatory’ i.e. a company pays dividend only when it is able to generate sufficient amount of earnings. But this seems to be inapplicable in the real world as is evident from the case of FPL Group. However it is anticipated by the analysts that the group will either cut dividend or keep it stable at the existing level of $2.48 per share. Historical chart of EPS & DPS- Analysis of dividend payout ratio of peers In 1993 FPL Group maintained a dividend payout ratio of 91% which is the highest as compared to its peers. During this period Duke Power Co. maintained a payout ratio of 68%, Florida Power Corp. had a payout ratio of 87% and Tampa Electric Co. had a payout ratio of 73%. This shows that the payout rtio of FPL Group is the highest among all the peers. Analysis of peer dividend pay-out ratio- Peer Comparison The Return on common stock reported by FPL Group in the year 1993 was 12.5%. This is a measure of the wealth generated by the company for its shareholders. FPL Group lags behind many of its peers on this parameter. As for the same year Carolina Power declared a return of 13.6%, Duke Power generated 13.2% etc. The above chart shows that FPL Group is behind many of its peers in terms of return generated for the shareholders. Even in terms of earnings per share the position of the company is similar. Its rivals like Duke Power, Scana Corp declared a higher EPS at $2.80 and $3.72 respectively in 1993 whereas for the same period FPL Group reported an EPS of $2.75. The customer mix of FPL Group comprises mainly of ‘residential’ whereas the share of its rivals in the sales to the ‘residential’ is quite low. The rivals of FPL have equally distributed their sales across “residential, commercial, industrial and utility companies.” But the sale of FPL is concentrated on residential and commercial. This shows that the customer mix of the company i.e. the percentage of sale to Industrial and Utility companies is very low at merely 8%. FPL Group can try and raise its sales to these two sections as this will enable the company to raise the revenues. The debt position of the company is more or less the same as that of its peers. The recent news about keeping the dividend payout ratio stable will save the resources of the company. With the help of the saved financial resources the company will be able to take up more profit yielding projects that will enable it improve the profitability in the long run. In terms of EPS the company ranks only third among its peers. The retention of profits in the business will facilitate the expansionary projects of the company and boost the profit margins. Anticipation of analysts For the year 1994 the analysts expect that FPL Group will either cut down dividend or keep it stable at $2.48. By doing this the company will be left with additional cash of approximately $150 million every year. Generally a cut in the dividend is followed by a fall in the share price of the company. The shares of FPL Group also dropped by more than 6% on the day Merrill Lynch’s Utilities analyst downgraded the investment ratings of the company due to expectations of revision in the dividend policy of the company. There are various reasons that are responsible for the fall in the share price of the company owing to cut in the dividend. One reason is that the market participants view a fall in the share price of the company as indication of fall in future earnings potential. This is the reason that many companies keep their dividend constant even in the event of a loss. The managers of these companies declare dividend even in times of loss so as to retain the confidence of the investors. They know that any slash in dividends will have a negative impact on their share price and hence maintain the dividend record. But this is not viable as it exerts pressure on the financials thus adding to the strain. Dividend Irrelevance There are theories that put forward the idea that dividend policy is irrelevant. As per this theory the firm’s value is unaffected by dividend policy as the investors are free to create desired income stream through ‘home-made dividends’. It is also said that the managers must not ignore the positive net present value projects just to please the investors. In fact if the managers can effectively convey the message signifying the necessity of a dividend cut the market may not react negatively. If the investors are convinced that the cut is essential for future earnings they may not react negatively. Additionally the companies can design their dividend policy as per the investment behavior of its clients. Like there are some high tax-bracket investors who would not be impacted by a dividend cut but again there are other classes of investors like retired individuals for whom dividend is an additional income and they are affected by such decisions. Therefore it is important that a company designs its dividend policy keeping in mind its class of investors. Future Prospects of FPL Group The surplus cash that FPL Group will be left after a dividend cut can be used for share repurchase. Repurchase of existing shares increases the confidence of the investors. This sends out the signal that the company management is confident about the future prospects and has a positive influence on the share price. Rather the lesser number of outstanding shares in the futures raises the future earnings per share of the company. As per the financial projections the net income of FPL Group is expected to rise at a consistent pace in the coming years. This may be on account of reduction in the financial expenses on account of reduction in the debt position over the years. Projected Net income- The money that is retained in the business can facilitate the future expansions of FPL Group. In fact the company can lower its debt exposure through the cash that is saved and thus raise the available income for the investors. The same is also evident from the projections of the company. In 1993 the percentage of long term debt in the company is 46% and this is expected to go down to 44% in the 1998. This will have a positive impact on the net income also as the interest burden of the company will also go down as a result of reduction in debt. Long-term debt projection- The projected low debt position in the coming years and the saved financial resources can facilitate the expansion of FPL Group. Conclusion Various theories have forwarded the idea that dividend policy does not have an impact on the share price of the company. But in reality the share price of the company usually falls when there is an announcement of dividend cut. This is referred to as ‘signaling effect’. A rise in dividend gives signals of strong future cash flows whereas a dividend cut signals that the management is not certain about the future and this is followed by a fall in share price. The same proved to be true for FPL Group as well whose shares fell on reports of a cut in dividend. For this reason the managers of the company are not very keen to slash dividends as they fear adverse market reaction. Reference Ross, A.S. Westerfield, R. Jordan, D.B. Fundamentals of corporate finance. Tata McGraw-Hill. Read More