DIVIDEND POLICY

GSN
 DIVIDEND BASICS
• Dividend refers to that part of profits of a company which is distributed by the company among its
shareholders.
• Dividend Payout ratio is decided by the BOD.

• Dividends convey information about company’s future earnings from management to investors.
Dividend Payout Ratio

It is the percentage of earnings paid to shareholders in the form of dividend. It is sometimes simply
referred to as the ‘Payout Ratio.'

The amount that is not paid to shareholders is retained by the company to pay off debt or to reinvest
in core operations.
Dividend Paid
Dividend Payout Ratio =
Net Income

NI −Dividend Paid
Retention Ratio = (or) 1- Payout Ratio
NI
 DIVIDEND BASICS (Cont.)

Dividend per share

Dividend Paid
DPS = (or) DPS = EPS × Dividend Payout Ratio
No.of Outstanding Shares

Dividend percentage

Dividend per share(Rs.) = Dividend Percentage × Face Value

Dividend Yield: Dividend yield is the financial ratio that measures the quantum of cash dividends
paid out to shareholders relative to the market value per share.

Dividend
Dividend yield = × 100
Current Share Price
 DIVIDEND DATES

Dividend Declaration Date: The date on which the next dividend payouts would be
done, is announced by the directors of the company. This usually have information on
the size of the dividend payout, ex-dividend date, record date and payout date.
Ex-Dividend Date: The date one business day before the record date is known as
the Ex-dividend date. On Ex-dividend date, the price of the share is reduced by the
amount of dividend declared. The shareholders who buy the stock on or after
ex-dividend date are not eligible for dividend.
Record Date: For getting dividend, investor’s name should be present on records of
the company as the holder of shares. So basically this date decides which all investors
are eligible for dividend payouts.
Payout Date: The payout date can be days, weeks or even months after the record
date. This is the date that the dividend is actually paid out to shareholders.
 FORMS OF CASH DIVIDEND

Cash Dividend

Regular Special Liquidating

Final Interim
IMPACT OF DIVIDEND ON FINANCIAL STATEMENTS

Type of Financial Statement Impact of Dividends

Balance sheet Will reduce the balance in the Cash and Other
Equity (Retained Earnings) accounts once the
dividends have been paid
Income statement Dividends have no impact here, since they are
not an expense
Statement of cash flows Reported as the Cash Outflow of Financing
Activities

Statement of Changes in Owner's Equity Reduces Retained Earnings under Other

It is a statement that tracks the changes in a Equity.
company's capital over a period of time, often a
year.
IMPACT OF CASH DIVIDEND ON KEY RATIOS

Impact of cash dividend on company’s Liquidity ratios

Decrease in Cash, current and quick ratios

Impact of cash dividend on Debt to Equity Ratio

Increase in DE Ratio
Impact of cash dividend on Debt to Asset Ratio

Increase in debt to asset

 STOCK DIVIDEND
• Bonus shares are additional shares given to the current shareholders without any additional cost, based
upon the number of shares that a shareholder owns. These are company's accumulated earnings which
are not given out in the form of dividends, but are converted into free shares.
• A company can use only any one or all of the following reserves — free reserves, securities premium
account and capital redemption reserve — for issue of bonus shares.
• If Investor A holds 200 shares of a company and a company declares 1:2 bonus, that is for every two
share, he gets 1 shares for free. That is total 100 shares for free and his total holding will increase to
300 shares.
• It is called Capitalisation of Reserve.
• One of the advantages to shareholders in the respect of stock dividends is the tax benefit. The receipt
of the stock dividends by the shareholder is not taxable as income.
• Shareholders may sell the bonus shares and meet their liquidity needs.
 BENEFITS OF STOCK DIVIDEND

(1) Immediately Realisable:

Bonus shares can be sold in the market immediately after a shareholder gets it.
(2) Not taxable:
Shareholders need not pay tax on the bonus shares.
(3) Increase in future Income:
Shareholders will get dividend on more shares in future than earlier
(4) Good Image increases the value in market:
Bonus shares create very good image of the company and the shares. Thereby it
results into increase in the value of the share in the market.
 STOCK SPLIT VS. STOCK DIVIDEND
Liabilities Assets
Equity Sh. Capital (Rs. 10 per share) 1,000 Assets 10,000
Reserve & Surplus 4,000
Loan 5,000

Before & After Stock Split (2:1) Before & After Stock Dividend (1:1)
Before Stock Split: FV – 10, No. of Shares 100 No. of Shares After stock dividend – 200
After Stock Split: FV-5, No. of Shares 200 FV remains same – Rs. 10
Capitalisation of Reserves – Rs. 1,000

Liabilities Assets Liabilities Assets

Equity Sh. 1,000 Assets 10,000 Equity Sh. 2,000 Assets 10,000
Capital Capital

Reserve & 4,000 Reserve & 3,000

Surplus Surplus

Loan 5,000 Loan 5,000

 STOCK SPLIT VS. STOCK DIVIDEND
Particulars Present After Split After 1:1 Bonus
Stock Price Rs. 700 Rs. 350 Rs.350
Face Value Rs. 10 Rs. 5 Rs. 10
Outstanding Shares 1 crore 2 crore 2 crore
Market Capitalisation 700 crore 700 crore 700 crore
Reserve & Surplus 500 crore 500 crore 150 crore

Why companies issue Bonus Shares?

➢ Reward the shareholders
➢ Increase the liquidity
➢ Bring the stock price in a reasonable price range
 INFOSYS BONUS

Year Ratio Before Bonus After Bonus

(No. of Shares) (No. of Shares)
1994 1:1 Bonus 100 200
1997 1:1 Bonus 200 400
1999 1:1 Bonus 400 800
1999 2:1 Stock Split 800 1600
2004 3:1 Bonus 1600 6,400
2006 1:1 Bonus 6,400 12,800
2014 1:1 Bonus 12,800 25,600
2015 1:1 Bonus 25,600 51,200
Value of Investment in 1994 = 100 shares × Rs. 100 = Rs. 10,000
Value of Investment in 2019 = 51,200 shares × Rs. 716 = 3,66,59,200
 IMPACT OF STOCK SPLIT & STOCK DIVIDEND

Before
Net Income – 1,00,000
Dividend – 20,000
No. of Shares – 5,000
Market price per share – 60

EPS – 20, DPS – 4, P/E (60/20) = 3

After Stock Spit After Stock Dividend
(2:1) (1:1)
EPS = 10 EPS = 10
DPS = 2 DPS = 2
P/E (30/10) = 3 P/E = 3
 REVERSE STOCK SPLITS

• A reverse split takes multiple shares from investors and replaces them with a smaller
number of shares in return.
• Instead of increasing the number of shares outstanding, a company may like to reduce
its number of outstanding shares.
• It reflects an aversion of company to see the prices of their shares falling below a certain
amount.
• The reverse split of 1:5 implies that for each five shares held by the shareholder, he
would receive one share in exchange.
• The most common reason for doing so is to meet a requirement from a stock exchange
to avoid having its shares delisted. For example, the New York Stock Exchange has
rules that allow it to delist a stock that trades below $1 per share for an extended period
of time.
 STOCK BUYBACK / REPURCHASE

• The act of purchasing its own shares by a company out of the surplus funds available with the company.
• Repurchase of stock is commonly known as buyback of shares.
• After buyback, the company can’t make a fresh issue of shares within a period of 12 months except by
way of bonus issue, conversion of warrants, stock option schemes or conversion of preference shares.
• The company can reissue the shares bought back after a period of 24 months form the date of last
buyback of securities.
Motives:
• Utilisation of surplus cash
• Utilisation of Reserves
• Increase promoters stake in the company
• Increase in market price of share (Undervaluation)
• Show Rosier Financials (Ratio)
 CLIENTELE EFFECT
• It argues that different group of investors desire different levels of dividend payment.
• Current clientele might choose to sell their stock if a firm changes
their dividend policy and deviates considerably from the investor's preferences.
Changes in policy can also lead to new clientele, whose preferences align with the
firm's new dividend policy.
• In equilibrium, the changes in clientele sets will not lead to any change in stock price.
• Clientele effect refers to the varying preferences for dividends of different groups of
investors, such as individuals, institutions and corporations.
• Companies structure their dividend policies consistent with preferences of their
clienteles.
• Miller and Modigliani note that once all the clienteles are satisfied, changing the dividend
policy would only entail changing clienteles and would not affect firm value.
 DIVIDEND POLICY

• Dividend Policy is a financial decision that refers to the proportion of the firm’s earnings to be paid
out to the shareholders.
• Certain vs. uncertain signals
DETERMINANTS OF DIVIDEND

• Trend of earnings
• Legal restrictions

• Nature of industry
• Age of the company
• Future financial requirement

• Desire and type of shareholders

• Taxation policy
 Dividend Policy

Irrelevance Relevance
Theory Theory

Miller and Walter’s Gordon’s

Modigliani Model Model
 MILLLER & MODIGLIANI MODEL

• Dividend policy is irrelevant since it has no effect on the price of stock and believes that it is the
investment policy that increases the firm’s wealth.
• Individual investor can create their own homemade dividend.

Assumptions:
1. No taxes and transaction costs.
2. Constant Investment Policy
3. Certain future profits

Dividend No Dividend (Homemade

Dividend)
Investment – 1,00,000 Dividend of Rs.10 per Sell 100 Shares
1000 shares @ Rs.100 per share
share
Cash – Rs. 10,000 Cash – Rs. 10,000
Stock value – Rs. 90,000 Stock value – Rs. 90,000
(90 per share)
 MM MODEL
𝐷𝐼 +𝑃1
P0 =
1+Ke
P1 = P0(1+ Ke) – D1
Market Price
P0 = Current Market price of the stock (Intrinsic value)
P1 = Expected market price at the end of year 1
Pt = The expected market price at the end of year t
D0 = Recent dividend already paid
D1 = Expected dividend at the end of year 1
Dt = Expected dividend at the end of year t
 WALTER MODEL

• Prof. James E Walter formed a model for share valuation that states that choice of
dividend policies almost always affects the value of the enterprise.
• The choice of an appropriate dividend policy affects the value of an enterprise.
Assumptions:
1. Retained earnings are the only source of finance, no external financing is used.
2. The rate of return (r) and the cost of capital (K) remain constant irrespective of any changes
in the investments.
3. All the earnings are either retained or distributed completely among the shareholders.
4. The EPS and DPS remain constant.
5. The firm has an indefinite life.
Relationship Firm Implications Payout Increase in
Category Ratio Payout
r > Ke Growth Firm Benefits the shareholders more if the Zero payout Decreases
r = return company reinvests the dividend rather firm value
k = cost than distributing it.
r < Ke Declining The shareholders are benefited more if 100% Increases firm
Firm the dividends are distributed rather than value
reinvested.
r = Ke Normal Firm It does not make any difference if the 0-100% No change in
company reinvested the dividends or firm value
distributed to shareholders
WALTER MODEL (Cont.)

r
D E−D ×
Ke
P= +
Ke Ke

Where, P = Price of Share

D = DPS
E = EPS
r (IRR) = Rate of return
Ke = Cost of Equity
 GORDON’S MODEL

“A bird in the hand is worth two in the bush”

• Given by Myron Gordon, also supports the doctrine that dividends are relevant to the share prices of a
firm.
• Investor prefer the certainty of current cash to future capital gains.
• This model indicates that the market value of the company’s share is the sum of the present values of
infinite future dividends to be declared.
Intrinsic Value = D1 / (k – g)
Dividends of Next year (D1) = Dividends in Current year × (1 + Growth Rate)

Assumptions:
1. Investors are risk averse in nature.
2. Company has no debt
3. Constant IRR (r) & Cost of Capital (k)
4. Perpetual earnings
5. Retention ratio and growth rate are constant.
6. No corporate tax
(a) One period
D1+P1
P0 =
1+𝑘𝑒 1

(b) Multiple period

P0 = Current market price
𝐷1 𝐷2 𝐷𝑛+𝑃𝑛
P0 = 1 + 2 + D1 = Expected Dividend [D0×(1+g)]
1+𝑘𝑒 1+𝑘𝑒 1+𝑘𝑒 𝑛 Ke = Rate of return expected by shareholders /
( c) Consistent Dividend Forever Cost of Equity
g = Dividend growth rate
𝐷1 r (IRR)= Rate of return earned on investments
P0 =
𝑘𝑒
(d) Constant growth
𝐷1
P0 =
𝑘𝑒 −𝑔
(e) Supernormal growth
 𝐸𝑃𝑆 × 𝑃𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑖𝑜
Market price per share =
𝑘−𝑔
Payout ratio = 1- Retention ratio
ke = cost of capital
g = growth rate

Market value > Intrinsic Value Overvalued

Market value < Intrinsic Value Undervalued
Market value = Intrinsic Value Fair value
 DIVIDEND DISTRIBUTION TAX (DDT)

• Companies are required to pay dividend distribution tax on the dividend paid to its
shareholders at the rate of 15 per cent plus applicable surcharge and cess (Effective
rate is 20.56%), in addition to the tax payable by the company on its profits.
• Dividend received from an indian company is exempt from tax for shareholder as the
company declaring such dividend already pays dividend distribution tax.
• Dividend received from a foreign company is taxable for shareholders. It will be
charged to tax under the head “income from other sources.”
• From 1st April 2020, the dividend shall be taxed only in the hands of the recipients at
their applicable rate.