The dividend payout ratio indicates the percentage of

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Unformatted text preview: tio dividend policy A dividend policy based on the payment of a certain percentage of earnings to owners in each dividend period. EXAMPLE Constant-Payout-Ratio Dividend Policy One type of dividend policy involves use of a constant payout ratio. The dividend payout ratio indicates the percentage of each dollar earned that is distributed to the owners in the form of cash. It is calculated by dividing the firm’s cash dividend per share by its earnings per share. With a constant-payout-ratio dividend policy, the firm establishes that a certain percentage of earnings is paid to owners in each dividend period. The problem with this policy is that if the firm’s earnings drop or if a loss occurs in a given period, the dividends may be low or even nonexistent. Because dividends are often considered an indicator of the firm’s future condition and status, the firm’s stock price may thus be adversely affected. Peachtree Industries, a miner of potassium, has a policy of paying out 40% of earnings in cash dividends. In periods when a loss occurs, the firm’s policy is to pay no cash dividends. Data on Peachtree’s earnings, dividends, and average stock prices for the past 6 years follow. Year Earnings/share Dividends/share Average price/share 2003 $0.50 $0.00 $42.00 2002 3.00 1.20 52.00 2001 1.75 0.70 48.00 2000 1.50 0.00 38.00 1999 2.00 0.80 46.00 1998 4.50 1.80 50.00 Dividends increased in 2001 and in 2002 but decreased in the other years. In years of decreasing dividends, the firm’s stock price dropped; when dividends increased, the price of the stock increased. Peachtree’s sporadic dividend payments appear to make its owners uncertain about the returns they can expect. CHAPTER 13 Hint Regulated utilities in low-growth areas can use a constant-payout-ratio dividend policy. Their capital requirements are usually low and their earnings are more stable than those of most firms. regular dividend policy A dividend policy based on the payment of a fixed-dollar dividend in each period. EXAMPLE Dividend Policy 571 Although some firms use a constant-payout-ratio dividend policy, it is not recommended. Regular Dividend Policy The regular dividend policy is based on the payment of a fixed-dollar dividend in each period. This policy provides the owners with generally positive information, thereby minimizing their uncertainty. Often, firms that use this policy increase the regular dividend once a proven increase in earnings has occurred. Under this policy, dividends are almost never decreased. The dividend policy of Woodward Laboratories, a producer of a popular artificial sweetener, is to pay annual dividends of $1.00 per share until per-share earnings have exceeded $4.00 for three consecutive years. At that point, the annual dividend is raised to $1.50 per share, and a new earnings plateau is established. The firm does not anticipate decreasing its dividend unless its liquidity is in jeopardy. Data for Woodward’s earnings, dividends, and average stock pri...
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