Dividend Policy and Share Prices

Topics: Stock market, Stock, Dividend Pages: 10 (2457 words) Published: November 26, 2012

In this paper the impact of dividend policy of the companies on the firm’s share prices is analysed and different views in the context of the semi-strong form of the efficient market hypothesis are contrasted. The overview of the traditional and most recent empirical investigations of the stock market reaction to the dividend announcements is provided and different findings are discussed and compared.

Three companies have been selected from the FTSE All share price index. These companies are Tesco, Burberry and Vodafone. These firms belong to different sectors of the economy. Tesco is the largest retailer in the UK, Burberry is a fashion firm and Vodafone is the telecommunication services company. The dividends and accounts have been retrieved from annual reports of the companies (Tesco, 2011; Burberry, 2011; Vodafone, 2011). The share prices were sourced from Yahoo Finance (2012). The copies of the company accounts are provided in the appendices. Dividend Policies of Companies

These three companies were chosen for the following reasons. Firstly, it was intended to choose large companies that have an established dividend policy and revenue of more than £1 billion a year. Secondly, the companies from different industries had to be analysed. Thirdly, both services sector and goods sector were intended to be analysed. Finally, it was interesting to compare both pro-cyclical firms (e.g. Burberry) and counter-cyclical firms (e.g. Vodafone). The former are very sensitive to the effects of the economic recession whereas the latter are less sensitive because consumers would still have to use mobile phones and services regardless of their financial position.

The dividend payout ratio has been calculated for these companies for the period from 2007 to 2011. The following formula was used:

Dividend payout ratio = dividends per share / earnings per share

The results are summarised in the following figure.

Figure 1 Dividend Payout Ratios

Source: Annual Reports of Tesco (2011), Burberry (2011) and Vodafone (2011)

The payout ratios indicate different dividend policies adopted by the three companies. Tesco’s policy is aimed at maintaining a constant dividend payout ratio, which is very common for mature industries such as retailing. In these industries the majority of the large companies are “cash cows” for the investors and therefore the dividend policy tends to show constant payout ratios, which inspires trust in the company and expectation of future stability.

In contrast, the dividend policies of Vodafone and Burberry are not aimed at a constant payout ratio. In fact, as the following figure demonstrates, the policies of Vodafone and Burberry are aimed at dividend growth.

Figure 2 Final Dividends

Source: Annual Reports of Tesco (2011), Burberry (2011) and Vodafone (2011)

However, whereas Vodafone demonstrates a “steady dividend growth strategy”, Burberry demonstrates the a strategy that does not show a specific pattern but can be interpreted as a signal to the market because in 2009 the company announced the dividends that were equal to the dividends announced in the previous year in spite of the accounting losses suffered by the firm which were reflected in negative earnings per share (Appendix C). This move can be interpreted as a sign that the management attempted to signal the market that the losses are temporary and the company was expected to recover quickly.

It is interesting to note that the latter policy is inconsistent with the position that dividends should be paid out of earnings rather than accumulated capital or reserves. Furthermore, the companies could undertake an alternative dividend policy which would imply linking the dividend payout to the investment opportunities that could be managed by firms (Brealey and Myers, 2003). If the company has many projects that offer positive net present value, then it would be recommended that dividends could be...
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