Aswath Damodaran

RETURNING  CASH  TO  THE  

OWNERS:  DIVIDEND  POLICY  
“Companies  don’t  have  cash.  They  hold  cash  for  
their  stockholders.”  
 First  Principles  
2

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should reflect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities

Aswath Damodaran

2

 Steps  to  the  Dividend  Decision…  
3

How much did you borrow?

Cashflows to Debt
(Principal repaid,
Interest
Expenses)
How good are your investment choices?

Cashflow Reinvestment back

from into the business
Operations
What is a reasonable cash balance?
Cashflows from
Operations to Cash held back
Equity Investors by the company

Cash available
for return to What do your
stockholders stockholders prefer?

Stock Buybacks

Cash Paid out

Dividends

Aswath Damodaran

3

 I.  Dividends  are  sJcky  
4

Dividend  Changes  at  US  companies  

80.00%  

70.00%  

60.00%  

50.00%  

Increase  
40.00%  
Decrease  

30.00%   No  change  

20.00%  

10.00%  

0.00%  

Aswath Damodaran

4

 The  last  quarter  of  2008  put  sJckiness  to  the  
test..  Number  of  S&P  500  companies  that…  
5

Quarter
Dividend Increase
Dividend initiated
Dividend decrease
Dividend suspensions

Q1 2007
102
1
1
1

Q2 2007
63
1
1
5

Q3 2007
59
2
2
0

Q4 2007
63
7
4
2

Q1 2008
93
3
7
4

Q2 2008
65
0
9
0

Q3 2008
45
2
6
8

Q4 2008
32
0
17
10

Aswath Damodaran

5

 6

Dividends  
Earnings  

2013  
II.  Dividends  tend  to  follow  earnings  

2012  
2011  
2010  
2009  
2008  
S&P  500:  Dividends  and  Earnings  -­‐  1960  to  2013  

2007  
2006  
2005  
2004  
2003  
2002  
2001  
2000  
1999  
1998  
1997  
1996  
1995  
1994  
1993  
1992  
1991  
1990  
1989  
1988  
1987  
1986  
1985  
1984  
1983  
1982  
1981  
1980  
1979  
1978  
1977  
1976  
1975  
1974  
1973  
1972  
1971  
1970  
1969  
1968  
1967  

Aswath Damodaran

1966  
1965  
1964  
1963  
1962  
1961  
1960  
Year  

120.00  

100.00  

80.00  

60.00  

40.00  

20.00  

0.00  
6

III.  Are  affected  by  tax  laws…  

In  2003   In  the  last  quarter  of  2012  

¨  As  the  possibility  of  tax  
rates  reverJng  back  to  
pre-­‐2003  levels  rose,  233  
companies  paid  out  $31  
billion  in  dividends.  
¨  Of  these  companies,  101  
had  insider  holdings  in  
excess  of  20%  of  the  
outstanding  stock.    
 IV.  More  and  more  firms  are  buying  back  stock,  
rather  than  pay  dividends...  
8

Stock Buybacks and Dividends: Aggregate for US Firms - 1989-2013

$600,000.00

$500,000.00

$400,000.00

$ Dividends & Buybacks

$300,000.00

$200,000.00

$100,000.00

$-

1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013

Year

Stock Buybacks
Dividends

Aswath Damodaran

8

 V.  And  there  are  differences  across  countries…  
9

Aswath Damodaran

9

 Measures  of  Dividend  Policy  
10

¨  Dividend  Payout  =  Dividends/  Net  Income  

¤  Measures  the  percentage  of  earnings  that  the  company  
pays  in  dividends  
¤  If  the  net  income  is  negaJve,  the  payout  raJo  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.  

Aswath Damodaran

10

 Dividend  Payout  RaJos  
11

Dividend  Payout  RaCos  in  2014  

18.00%  

16.00%  

14.00%  

12.00%  

10.00%  
Global  

8.00%   US  

6.00%  

4.00%  

2.00%  

0.00%  
0-­‐10%   10-­‐20%   20-­‐30%   30-­‐40%   40-­‐50%   50-­‐60%   60-­‐70%   70-­‐80%   70-­‐90%   90-­‐100%   >100%  

Aswath Damodaran

11

 Dividend  Yields:  January  2013  
12

Dividend  Yields  in  2014  

18.00%  

16.00%  

14.00%  

12.00%  

10.00%  
Global  
8.00%  
US  
6.00%  

4.00%  

2.00%  

0.00%  

Aswath Damodaran

12

13
Aswath Damodaran

 Dividend  Yields  and  Payout  RaJos:  Growth  
Classes  
14

Dividend  Yields  and  Payout  Ra:os:  By  Growth  Class  

50.00%   4.00%  

45.00%  
3.50%  

40.00%  
3.00%  
35.00%  

2.50%  
30.00%  

25.00%   2.00%   Dividend  Payout  raJo  

Dividend  Yield  
20.00%  
1.50%  

15.00%  
1.00%  
10.00%  

0.50%  
5.00%  

0.00%   0.00%  
0-­‐3%   3-­‐5%   5-­‐10%   10-­‐15%   15-­‐20%   20-­‐25%   >25%  

Aswath Damodaran

14

 Dividend  Policy:  Disney,  Vale,  Tata  Motors,  
Baidu  and  Deutsche  Bank  
15

Disney Vale Tata Motors Baidu Deutsche Bank

Dividend Yield - Last 12 months 1.09% 6.56% 1.31% 0.00% 1.96%
Dividend Payout ratio - Last 12 months 21.58% 113.45% 16.09% 0.00% 362.63%
Dividend Yield - 2008-2012 1.17% 4.01% 1.82% 0.00% 3.14%
Dividend Payout - 2008-2012 17.11% 37.69% 15.53% 0.00% 37.39%

Aswath Damodaran

15

Three  Schools  Of  Thought  On  Dividends  

1.  If    there  are  no  tax  disadvantages  associated  with  

dividends  &    companies  can  issue  stock,  at  no  issuance  
cost,  to  raise  equity,  whenever  needed  
Dividends  do  not  maGer,  and  dividend  policy  does  not  affect  
value.  
2.  If  dividends  create  a  tax  disadvantage  for  investors  
(relaJve  to  capital  gains)  
Dividends  are  bad,  and  increasing  dividends  will  reduce  value  
3.   If  dividends  create  a  tax  advantage  for  investors  
(relaJve  to  capital  gains)  and/or  stockholders  like  
dividends  
Dividends  are  good,  and  increasing  dividends  will  increase  value  

Aswath Damodaran

16

 The  balanced  viewpoint  
17

¨  If  a  company  has  excess  cash,  and  few  good  

investment  opportuniJes  (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  opportuniJes  (NPV>0),  

returning  money  to  stockholders  (dividends  or  stock  
repurchases)  is  bad.  

Aswath Damodaran

17

 The  Dividends  don’t  majer  school  
The  Miller  Modigliani  Hypothesis  
18

¨  The  Miller-­‐Modigliani  Hypothesis:  Dividends  do  not  affect  value  

¨  Basis:  
¤  If  a  firm's  investment  policies  (and  hence  cash  flows)  don't  change,  the  value  of  the  
firm  cannot  change  as  it  changes  dividends.    
¤  If  a  firm  pays  more  in  dividends,  it  will  have  to  issue  new  equity  to  fund  the  same  
projects.  By  doing  so,  it  will  reduce  expected  price  appreciaJon  on  the  stock  but  it  
will  be  offset  by  a  higher  dividend  yield.  
¤  If  we  ignore  personal  taxes,  investors  have  to  be  indifferent  to  receiving  either  
dividends  or  capital  gains.  
¨  Underlying  AssumpJons:  
(a)  There  are  no  tax  differences  to  investors  between  dividends  and  capital  gains.  
(b)  If  companies  pay  too  much  in  cash,  they  can  issue  new  stock,  with  no  flotaJon  costs  
or  signaling  consequences,  to  replace  this  cash.  
(c)  If  companies  pay  too  lijle  in  dividends,  they  do  not  use  the  excess  cash  for  bad  
projects  or  acquisiJons.  

Aswath Damodaran

18

 II.  The  Dividends  are  “bad”  school:  And  the  
evidence  to  back  them  up…  
19

 Tax  rates  on  dividends  and  capital  gains-­‐  US  

100.00%  

90.00%  

80.00%  

70.00%  

60.00%  

50.00%  

40.00%  

30.00%  

20.00%  

10.00%  

0.00%  
1916

1918

1920

1922

1924

1926

1928

1930

1932

1934

1936

1938

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2013

2011

Dividend  tax  rate   Capital  gains  tax  rate  

Aswath Damodaran

19

 What  do  investors  in  your  stock  think  about  
dividends?  Clues  on  the  ex-­‐dividend  day!  
20

¨  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  
addiJon,  assume  that  you  have  owned  the  stock  for  several  years.    

Initial buy
Pb
Pa

At $P

Ex-dividend day

Dividend = $ D

P  =  Price  at  which  you  bought  the  stock  a  “while”  back  

Pb=  Price  before  the  stock  goes  ex-­‐dividend  
Pa=Price  aper  the  stock  goes  ex-­‐dividend  
D  =  Dividends  declared  on  stock  
to,  tcg  =  Taxes  paid  on  ordinary  income  and  capital  gains  respecJvely  

Aswath Damodaran

20

 Cashflows  from  Selling  around  Ex-­‐Dividend  Day  
21

¨  The  cash  flows  from  selling  before  ex-­‐dividend  day  are:  
Pb  -­‐  (Pb  -­‐  P)  tcg    
¨  The  cash  flows  from  selling  aper  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  
aper  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 1− t o
=
D 1− t cg
Aswath Damodaran

21

 IntuiJve  ImplicaJons  
22

¨  The  relaJonship  between  the  price  change  on  the  ex-­‐
dividend  day  and  the  dollar  dividend  will  be  determined  by  
the  difference  between  the  tax  rate  on  dividends  and  the  tax  
rate  on  capital  gains  for  the  typical  investor  in  the  stock.  
Tax Rates
Ex-dividend day behavior

If dividends and capital gains are Price change = Dividend

taxed equally

If dividends are taxed at a higher Price change < Dividend

rate than capital gains

If dividends are taxed at a lower Price change > Dividend

rate than capital gains

Aswath Damodaran

22

 The  empirical  evidence…  
23

1966-­‐1969  

•  Ordinary  tax  rate  =  70%  

•  Capital  gains  rate  =  28%  
•  Price  change  as  %  of  Dividend  =  78%  

1981-­‐1985  

•  Ordinary  tax  rate  =  50%  

•  Capital  gains  rate  =  20%  
•  Price  change  as  %  of  Dividend  =  85%  

1986-­‐1990  

•  Ordinary  tax  rate  =  28%  

•  Capital  gains  rate  =  28%  
•  Price  change  as  %  of  Dividend  =  90%  

Aswath Damodaran

23

 Dividend  Arbitrage  
24

¨  Assume  that  you  are  a  tax  exempt  investor,  and  that  
you  know  that  the  price  drop  on  the  ex-­‐dividend  day  
is  only  90%  of  the  dividend.  How  would  you  exploit  
this  differenJal?  
a.  Invest  in  the  stock  for  the  long  term  
b.  Sell  short  the  day  before  the  ex-­‐dividend  day,  buy  on  the  
ex-­‐dividend  day  
c.  Buy  just  before  the  ex-­‐dividend  day,  and  sell  aper.  
d.  ______________________________________________  

Aswath Damodaran

24

 Example  of  dividend  capture  strategy  with  tax  
factors  
25

¨  XYZ  company  is  selling  for  $50  at  close  of  trading  May  3.  
On  May  4,  XYZ  goes  ex-­‐dividend;  the  dividend  amount  is  
$1.  The  price  drop  (from  past  examinaJon  of  the  data)  is  
only  90%  of  the  dividend  amount.    
¨  The  transacJons  needed  by  a  tax-­‐exempt  U.S.  pension  
fund  for  the  arbitrage  are  as  follows:  
¤  1.  Buy  1  million  shares  of  XYZ  stock  cum-­‐dividend  at  $50/share.  
¤  2.  Wait  Jll  stock  goes  ex-­‐dividend;  Sell  stock  for  $49.10/share  
(50  -­‐  1*  0.90)  
¤  3.  Collect  dividend  on  stock.  
¨  Net  profit  =  -­‐  50  million  +  49.10  million  +  1  million  =  
$0.10  million  

Aswath Damodaran

25

 Two  bad  reasons  for  paying  dividends  
1.  The  bird  in  the  hand  fallacy  
26

¨  Argument:  Dividends  now  are  more  certain  than  

capital  gains  later.  Hence  dividends  are  more  
valuable  than  capital  gains.  Stocks  that  pay  
dividends  will  therefore  be  more  highly  valued  than  
stocks  that  do  not.  
¨  Counter:  The  appropriate  comparison  should  be  
between  dividends  today  and  price  appreciaJon  
today.  The  stock  price  drops  on  the  ex-­‐dividend  day.  

Aswath Damodaran

26

 2.  We  have  excess  cash  this  year…  
27

¨  Argument:  The  firm  has  excess  cash  on  its  hands  this  
year,  no  investment  projects  this  year  and  wants  to  
give  the  money  back  to  stockholders.  
¨  Counter:  So  why  not  just  repurchase  stock?  If  this  is  

a  one-­‐Jme  phenomenon,  the  firm  has  to  consider  

future  financing  needs.      The  cost  of  raising  new  
financing  in  future  years,  especially  by  issuing  new  
equity,  can  be  staggering.  

Aswath Damodaran

27

 The  Cost  of  Raising  Capital  
28

Figure 10.12: Issuance Costs for Stocks and Bonds

25.00%

20.00%

Cost as % of funds raised

15.00%

10.00%

5.00%

0.00%

Under $1 mil
$1.0-1.9 mil
$2.0-4.9 mil
$5.0-$9.9 mil
$10-19.9 mil
$20-49.9 mil
$50 mil and over

Size of Issue

Cost of Issuing bonds
Cost of Issuing Common Stock

Aswath Damodaran

28

 Three  “good”  reasons  for  paying  dividends…  
29

¨  Clientele  Effect:  The  investors  in  your  company  like  

dividends.  
¨  The  Signalling  Story:  Dividends  can  be  signals  to  the  
market  that  you  believe  that  you  have  good  cash  
flow  prospects  in  the  future.  
¨  The  Wealth  AppropriaJon  Story:  Dividends  are  one  
way  of  transferring  wealth  from  lenders  to  equity  
investors  (this  is  good  for  equity  investors  but  bad  
for  lenders)  

Aswath Damodaran

29

 1.  The  Clientele  Effect  
The  “strange  case”  of  CiJzen’s  UJlity  
30

Class A
shares pay
cash
dividend



Class B
shares offer
the same
amount as a
stock
dividend &
can be
converted to
class A
Aswath Damodaran
shares
30

 Evidence  from  Canadian  firms  
31

Company
Premium for cash dividend shares

Consolidated Bathurst
+ 19.30%

Donfasco
+ 13.30%

Dome Petroleum
+ 0.30%

Imperial Oil
+12.10%

Newfoundland Light & Power
+ 1.80%

Royal Trustco
+ 17.30%

Stelco
+ 2.70%

TransAlta
+1.10%

Average across companies
+ 7.54%

Aswath Damodaran

31

 A  clientele  based  explanaJon  
32

¨  Basis:  Investors  may  form  clienteles  based  upon  

their  tax  brackets.  Investors  in  high  tax  brackets  may  
invest  in  stocks  which  do  not  pay  dividends  and  
those  in  low  tax  brackets  may  invest  in  dividend  
paying  stocks.    
¨  Evidence:  A  study  of  914  investors'  poryolios  was  
carried  out  to  see  if  their  poryolio  posiJons  were  
affected  by  their  tax  brackets.  The  study  found  that    
¤  (a)  Older  investors  were  more  likely  to  hold  high  dividend  
stocks  and  
¤  (b)  Poorer  investors  tended  to  hold  high  dividend  stocks  

Aswath Damodaran

32

Results  from  Regression:  Clientele  Effect  

D  i  v  i  d  e  n  d    Y  
  ie     l  d  t    =  
   a  
   +  
   b  
   β  
  t    +  
   c  
   A  
  g  e  t    +  
   d  
   I  n  
  c  o  m  e  t    +  
   e  
   D  
  i  f  f  e  r  e  n  t  i  a  l    T  
  a  x    R  a  
  t  e  t    +  
   ε  
  t  
V  a  r  i  a  b  l  e   C  oe  
  f  f  i  c  i  e  n  t   I  mp  
  l  i  e  s  
C  o  n  s  t  a  n  t   4  .  2  2  %  
B  e  t  a    C  o  
  e  f  f  i  c  i  e  n  t   -­‐  2  .  1  4  5   H  i  g  h  e  r    b  
  e  t  a    s  
  t  o  c  k  s    p  
  a  y    l    o  w  e  r    d  
  i  v  i  d  e  n  d  s  .  
A  g  e  /  1  0  0   3  .  1  3  1   F  i  r  m  s    w  
  i  t  h    o  
  l  d  e  r    i    n  v  e  s  t  o  r  s    p  
  a  y    h  
  i  g  h  e  r  
d  i  v  i  d  e  n  d  s  .  
I  n  c  o  m  e  /  1  0  0  0   -­‐  3  .  7  2  6   F  i  r  m  s    w  
  i  t  h    w  
  e  a  l  t  h  i  e  r    i    n  v  e  s  t  o  r  s    p  
  a  y    l    o  w  e  r  
d  i  v  i  d  e  n  d  s  .  
D  i  f  f  e  r  e  n  t  i  a  l    T  
  a  x    R  a  
  t  e   -­‐  2  .  8  4  9   I  f    o  
  r  d  i  n  a  r  y    i    n  c  o  m  e    i    s    t  
 a  x  e  d    a  
  t    a  
   h  
  i  g  h  e  r    r  
  a  t  e  
t  h  a  n    c  
  a  p  i  t  a  l    g  
  a  i  n  s  ,    t  
 h  e    f  
  i  r  m    p  
  a  y  s    l    e  s  s  
d  i  v  i  d  e  n  d  s  .  
 Dividend  Policy  and  Clientele  
34

¨  Assume  that  you  run  a  phone  company,  and  that  you  have  
historically  paid  large  dividends.  You  are  now  planning  to  
enter  the  telecommunicaJons  and  media  markets.  Which  of  
the  following  paths  are  you  most  likely  to  follow?  
a.  Courageously  announce  to  your  stockholders  that  you  plan  
to  cut  dividends  and  invest  in  the  new  markets.  
b.  ConJnue  to  pay  the  dividends  that  you  used  to,  and  defer  
investment  in  the  new  markets.  
c.  ConJnue  to  pay  the  dividends  that  you  used  to,  make  the  
investments  in  the  new  markets,  and  issue  new  stock  to  
cover  the  shoryall  
d.  Other  
Aswath Damodaran

34

 2.  Dividends  send  a  signal”  
Increases  in  dividends  are  good  news..  
35

Aswath Damodaran

35

 But  higher  or  new  dividends  may  signal  
bad  news  (not  good)  
36

Dividend  IniCaCons  and  Earnings  Growth  

45.00%  

40.00%  

35.00%  
Annual  Earnings  Growth  Rate  

30.00%  

25.00%  

20.00%  

15.00%  

10.00%  

5.00%  

0.00%  
-­‐4   -­‐3   -­‐2   -­‐1   1   2   3   4  
Year  relaCve  to  dividend  iniCaCon  (Before  and  aUer)  

Aswath Damodaran

36

Both  dividend  increases  and  decreases  are  
becoming  less  informaJve…  

Market Reaction to Dividend Changes over time: US companies

1.00%  

0.00%  
1962-­‐1974   1975-­‐1987   1988-­‐2000  

-­‐1.00%  

Dividend  Increases  
-­‐2.00%  
Dividend  Decreases  

-­‐3.00%  

-­‐4.00%  

-­‐5.00%  

-­‐6.00%  
3.  Dividend  increases  may  be  good  for  
stocks…  but  bad  for  bonds..  

EXCESS RETURNS ON STOCKS AND BONDS AROUND DIVIDEND CHANGES!

0.5! Stock price rises

0!
t:-! -12! -9! -6! -3! 0! 3! 6! 9! 12! 15!
-0.5!15! CAR (Div Up)!
CAR!
-1! CAR (Div down)!

-1.5!

Bond price drops

-2!
Day (0: Announcement date)!
 What  managers  believe  about  dividends…  
39

Aswath Damodaran

39

 First  Principles  
40

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should reflect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities

Aswath Damodaran

40

 Aswath Damodaran
1

ASSESSING  DIVIDEND  POLICY:  

OR  HOW  MUCH  CASH  IS  TOO  
MUCH?  
It  is  my  cash  and  I  want  it  now…  
 The  Big  Picture…  
2

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should reflect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities

Aswath Damodaran

2

 Assessing  Dividend  Policy  
3

¨  Approach  1:  The  Cash/Trust  Nexus  

¤  Assess  how  much  cash  a  firm  has  available  to  pay  in  
dividends,  relaRve  what  it  returns  to  stockholders.  
Evaluate  whether  you  can  trust  the  managers  of  the  
company  as  custodians  of  your  cash.  
¨  Approach  2:  Peer  Group  Analysis  
¤  Pick  a  dividend  policy  for  your  company  that  makes  it  
comparable  to  other  firms  in  its  peer  group.  

Aswath Damodaran

3

 I.  The  Cash/Trust  Assessment  
4

Step  1:  How    much  did  the  the  company  actually  pay  
out  during  the  period  in  quesRon?  
Step  2:  How  much  could  the  company  have  paid  out  
during  the  period  under  quesRon?  
Step  3:  How  much  do  I  trust  the  management  of  this  
company  with  excess  cash?  
¤  How  well  did  they  make  investments  during  the  period  in  
quesRon?  
¤  How  well  has  my  stock  performed  during  the  period  in  
quesRon?  
Aswath Damodaran

4

 How  much  has  the  company  returned  to  
stockholders?  
5

¨  As  firms  increasing  use  stock  buybacks,  we  have  to  

measure  cash  returned  to  stockholders  as  not  only  
dividends  but  also  buybacks.  
¨  For  instance,  for  the  five  companies  we  are  

analyzing  the  cash  returned  looked  as  follows.  

  Disney   Vale   Tata  Motors   Baidu   Deutsche  Bank  
Year   Dividends   Buybacks   Dividends   Buybacks   Dividends   Buybacks   Dividends   Buybacks   Dividends   Buybacks  
2008   $648     $648     $2,993     $741     7,595₹     0₹     ¥0     ¥0     2,274  €   0  €  
2009   $653     $2,669     $2,771     $9     3,496₹     0₹     ¥0     ¥0     309  €   0  €  
2010   $756     $4,993     $3,037     $1,930     10,195₹     0₹     ¥0     ¥0     465  €   0  €  
2011   $1,076     $3,015     $9,062     $3,051     15,031₹     0₹     ¥0     ¥0     691  €   0  €  
2012   $1,324     $4,087     $6,006     $0     15,088₹     970₹     ¥0     ¥0     689  €   0  €  
2008-­‐12   $4,457     $15,412     $23,869     $5,731     51,405₹     970₹     ¥0     ¥0     ¥4,428     ¥0    

Aswath Damodaran

5

 A  Measure  of  How  Much  a  Company  Could  have  
Afforded  to  Pay  out:  FCFE  
6

¨  The  Free  Cashflow  to  Equity  (FCFE)  is  a  measure  of  how  much  cash  
is  lei  in  the  business  aier  non-­‐equity  claimholders  (debt  and  
preferred  stock)  have  been  paid,  and  aier  any  reinvestment  
needed  to  sustain  the  firm’s  assets  and  future  growth.  
 Net  Income  
 +  DepreciaRon  &  AmorRzaRon      
 =  Cash  flows  from  OperaRons  to  Equity  Investors  
 -­‐  Preferred  Dividends  
 -­‐  Capital  Expenditures    
 -­‐  Working  Capital  Needs    
 =  FCFE  before  net  debt  cash  flow  (Owner’s  Earnings)  
 +  New  Debt  Issues  
 -­‐  Debt  Repayments  
 =  FCFE  aier  net  debt  cash  flow  

Aswath Damodaran

6

 EsRmaRng  FCFE  when  Leverage  is  Stable  
7

¨  The  cash  flow  from  debt  (debt  issue,  neoed  out  against  repayment)  can  
be  a  volaRle  number,  creaRng  big  increases  or  decreases  in  FCFE,  
depending  upon  the  period  examined.  
¨  To  provide  a  more  balanced  measure,  you  can  esRmate  a  FCFE,  assuming  
a  stable  debt  raRo  had  been  used  to  fund  reinvestment  over  the  period.  
Net  Income  
-­‐  (1-­‐  Debt  RaRo)    (Capital  Expenditures  -­‐  DepreciaRon)  
-­‐  (1-­‐  Debt  RaRo)  Working  Capital  Needs  
=  Free  Cash  flow  to  Equity  
Debt  RaRo  =  Debt/Capital  RaRo  (either  an  actual  or  a  target)  

Aswath Damodaran

7

Disney’s  FCFE  and  Cash  Returned:  2008  –  
2012  
 
2012
2011
2010
2009
2008
Aggregate

Net Income
$6,136
$5,682
$4,807
$3,963
$3,307
$23,895

- (Cap. Exp - Depr)
$604
$1,797
$1,718
$397
$122
$4,638

- ∂ Working Capital
($133)
$940
$950
$308
($109)
$1,956

Free CF to Equity (pre-debt)
$5,665
$2,945
$2,139
$3,258
$3,294
$17,301

+ Net Debt Issued
$1,881
$4,246
$2,743
$1,190
($235)
$9,825

= Free CF to Equity (actual debt)
$7,546
$7,191
$4,882
$4,448
$3,059
$27,126

Free CF to Equity (target debt ratio)
$5,720
$3,262
$2,448
$3,340
$3,296
$18,065

Dividends
$1,324
$1,076
$756
$653
$648
$4,457    
Dividends + Buybacks
$5,411
$4,091
$5,749
$3,322
$1,296
$19,869

Disney returned about $1.5 billion more than the $18.1

billion it had available as FCFE with a normalized debt
ratio of 11.58% (its current debt ratio).

Aswath Damodaran

8

 How  companies  get  big  cash  balances:  
Microsoi  in  1996…  
9

¨  Consider  the  following  inputs  for  Microsoi  in  1996.    

¤  Net  Income  =  $2,176  Million  

¤  Capital  Expenditures  =  $494  Million  

¤  DepreciaRon  =  $  480  Million  

¤  Change  in  Non-­‐Cash  Working  Capital  =  $  35  Million  

¤  Debt  =  None  

FCFE  =    Net  Income  -­‐  (Cap  ex  -­‐  Depr)  –  Change  in  non-­‐cash  WC  –  Debt  CF  
         =  $  2,176  -­‐  (494  -­‐  480)  -­‐  $  35      -­‐  0        =    $  2,127  Million  
¨  By  this  esRmaRon,  Microsoi  could  have  paid  $  2,127  Million  in  dividends/
stock  buybacks  in  1996.  They  paid  no  dividends  and  bought  back  no  stock.    
Where  will  the  $2,127  million  show  up  in  Microsoi’s  balance  sheet?  

Aswath Damodaran

9

FCFE  for  a  Bank?  

¨  We  redefine  reinvestment  as  investment  in  regulatory  capital.    

FCFEBank=  Net  Income  –  Increase  in  Regulatory  Capital  (Book  Equity)  
¨  Consider  a  bank  with  $  10  billion  in  loans  outstanding  and  book  equity  of  $  750  
million.  If  it  maintains  its  capital  raRo  of  7.5%,  intends  to  grow  its  loan  base  by  
10%  (to  $11  and  expects  to  generate  $  150  million  in  net  income:  
FCFE  =  $150  million  –  (11,000-­‐10,000)*  (.075)  =  $75  million  
Deutsche Bank: FCFE estimates (November 2013)

Current 1 2 3 4 5
Risk Adjusted Assets (grows
3% each year) 439,851 € 453,047 € 466,638 € 480,637 € 495,056 € 509,908 €
Tier 1 as % of Risk Adj assets 15.13% 15.71% 16.28% 16.85% 17.43% 18.00%
Tier 1 Capital 66,561 € 71,156 € 75,967 € 81,002 € 86,271 € 91,783 €
Change in regulatory capital 4,595 € 4,811 € 5,035 € 5,269 € 5,512 €
Book Equity 76,829 € 81,424 € 86,235 € 91,270 € 96,539 € 102,051 €
ROE (increases to 8%) -1.08% 0.74% 2.55% 4.37% 6.18% 8.00%
Net Income -716 € 602 € 2,203 € 3,988 € 5,971 € 8,164 €
- Investment in Regulatory
Capital 4,595 € 4,811 € 5,035 € 5,269 € 5,512 €
FCFE -3,993 € -2,608 € -1,047 € 702 € 2,652 €
Aswath Damodaran

10

Dividends  versus  FCFE:  Across  the  globe    

Figure  11.2:  Dividends  versus  FCFE  in  2014  

70.00%  

60.00%  

50.00%  

FCFE<0,  No  dividends  

40.00%  
FCFE<0,  Dividends  

FCFE>0,  FCFE<Dividends  
30.00%  
FCFE>0,  No  dividends  

FCFE>0,FCFE>Dividends  
20.00%  

10.00%  

0.00%  
Australia,  NZ   Developed   Emerging   Japan   United  States   Global  
and  Canada   Europe   Markets  

Aswath Damodaran

11

 Cash  Buildup  and  Investor  Blowback:  
Chrysler  in  1994  
12

Chrysler: FCFE, Dividends and Cash Balance

$3,000 $9,000

$8,000
$2,500

$7,000

$2,000
$6,000

Cash Balance
$1,500
Cash Flow

$5,000

$4,000
$1,000

$3,000
$500

$2,000

$0
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 $1,000

($500) $0
Year

= Free CF to Equity = Cash to Stockholders Cumulated Cash

Aswath Damodaran

12

 6  ApplicaRon  Test:  EsRmaRng  your  firm’s  FCFE  
13

¨  In  General,        If  cash  flow  statement  used  

Net  Income        Net  Income  
+  DepreciaRon  &  AmorRzaRon    +  DepreciaRon  &  AmorRzaRon  
-­‐  Capital  Expenditures      +  Capital  Expenditures  
-­‐  Change  in  Non-­‐Cash  Working  Capital  +  Changes  in  Non-­‐cash  WC  
-­‐  Preferred  Dividend      +  Preferred  Dividend  
-­‐  Principal  Repaid      +  Increase  in  LT  Borrowing  
+  New  Debt  Issued      +  Decrease  in  LT  Borrowing  
         +  Change  in  ST  Borrowing  
=  FCFE        =  FCFE  
¨  Compare  to  
Dividends  (Common)      Common  Dividend      
+  Stock  Buybacks        Stock  Buybacks    

Aswath Damodaran

13

 A  PracRcal  Framework  for  Analyzing  Dividend  
Policy  
14

How much did the firm pay out? How much could it have afforded to pay out?"
What it could have paid out! What it actually paid out!
Net Income" Dividends"
- (Cap Ex - Depr’n) (1-DR)" + Equity Repurchase"
- Chg Working Capital (1-DR)"
= FCFE"

Firm pays out too little" Firm pays out too much"
FCFE > Dividends" FCFE < Dividends"

Do you trust managers in the company with! What investment opportunities does the !
your cash?! firm have?!
Look at past project choice:" Look at past project choice:"
Compare" ROE to Cost of Equity" Compare" ROE to Cost of Equity"
ROC to WACC" ROC to WACC"

Firm has history of " Firm has history" Firm has good " Firm has poor "
good project choice " of poor project " projects" projects"
and good projects in " choice"
the future"

Give managers the " Force managers to " Firm should " Firm should deal "
flexibility to keep " justify holding cash " cut dividends " with its investment "
cash and set " or return cash to " and reinvest " problem first and "
dividends" stockholders" more " then cut dividends"

Aswath Damodaran

14

 A  Dividend  Matrix  
15

Quality of projects taken: Excess Returns

Poor projects Good projects

Cash Returned, relative to Free Cash flow to Equity

Cash Return < FCFE
Cash Surplus + Poor Cash Surplus + Good
Projects Projects
Significant pressure to Maximum flexibility in
pay out more to setting dividend policy
stockholders as
dividends or stock
buybacks
Cash return > FCFE

Cash Deficit + Poor Cash Deficit + Good

Projects Projects
Reduce or eliminate Reduce cash payout, if
cash return but real any, to stockholders
problem is in
investment policy.

Aswath Damodaran

15

 More  on  Microsoi  
16

¨  Microsoi  had  accumulated  a  cash  balance  of  $  43  billion  

by  2002by  paying  out  no  dividends  while  generaRng  
huge  FCFE.  At  the  end  of  2003,  there  was  no  evidence  
that  Microsoi  was  being  penalized  for  holding  such  a  
large  cash  balance  or  that  stockholders  were  becoming  
resRve  about  the  cash  balance.  There  was  no  hue  and  
cry  demanding  more  dividends  or  stock  buybacks.  Why?  

¨  In  2004,  Microsoi  announced  a  huge  special  dividend  of  

$  33  billion  and  made  clear  that  it  would  try  to  return  
more  cash  to  stockholders  in  the  future.  What  do  you  
think  changed?  

Aswath Damodaran

16

 Case  1:  Disney  in  2003  
17

¨  FCFE  versus  Dividends  

¤  Between  1994  &  2003,  Disney  generated  $969  million  in  FCFE  each  
year.    
¤  Between  1994  &  2003,  Disney  paid  out  $639  million  in  dividends  and  
stock  buybacks  each  year.  
¨  Cash  Balance  
¤  Disney  had  a  cash  balance  in  excess  of  $  4  billion  at  the  end  of  2003.  
¨  Performance  measures  
¤  Between  1994  and  2003,  Disney  has  generated  a  return  on  equity,  on  
it’s  projects,  about  2%  less  than  the  cost  of  equity,  on  average  each  
year.  
¤  Between  1994  and  2003,  Disney’s  stock  has  delivered  about  3%  less  
than  the  cost  of  equity,  on  average  each  year.  
¤  The  underperformance  has  been  primarily  post  1996  (aier  the  Capital  
CiRes  acquisiRon).  
Aswath Damodaran

17

 Can  you  trust  Disney’s  management?  
18

¨  Given  Disney’s  track  record  between  1994  and  2003,  if  
you  were  a  Disney  stockholder,  would  you  be  
comfortable  with  Disney’s  dividend  policy?  
a.  Yes  
b.  No  
¨  Does  the  fact  that  the  company  is  run  by  Michael  Eisner,  
the  CEO  for  the  last  10  years  and  the  iniRator  of  the  Cap  
CiRes  acquisiRon  have  an  effect  on  your  decision.  
a.  Yes  
b.  No  

Aswath Damodaran

18

 The  Booom  Line  on  Disney  Dividends  in  2003  
19

¨  Disney  could  have  afforded  to  pay  more  in  dividends  
during  the  period  of  the  analysis.  
¨  It  chose  not  to,  and  used  the  cash  for  acquisiRons  
(Capital  CiRes/ABC)  and  ill  fated  expansion  plans  
(Go.com).  
¨  While  the  company  may  have  flexibility  to  set  its  
dividend  policy  a  decade  ago,  its  acRons  over  that  
decade  have  frioered  away  this  flexibility.  
¨  Booom  line:  Large  cash  balances  would  not  be  tolerated  
in  this  company.  Expect  to  face  relentless  pressure  to  pay  
out  more  dividends.  

Aswath Damodaran

19

Following  up:  Disney  in  2009  

¨  Between  2004  and  2008,  Disney  made  significant  changes:  

¤  It  replaced  its  CEO,  Michael  Eisner,  with  a  new  CEO,  Bob  Iger,  who  at  
least  on  the  surface  seemed  to  be  more  recepRve  to  stockholder  
concerns.  
¤  Its  stock  price  performance  improved  (posiRve  Jensen’s  alpha)  
¤  Its  project  choice  improved  (ROC  moved  from  being  well  below  cost  of  
capital  to  above)  
¨  The  firm  also  shiied  from  cash  returned  <  FCFE  to  cash  
returned  >  FCFE  and  avoided  making  large  acquisiRons.  
¨  If  you  were  a  stockholder  in  2009  and  Iger  made  a  plea  to  
retain  cash  in  Disney  to  pursue  investment  opportuniRes,  
would  you  be  more  recepRve?  
a.  Yes  
b.  No  

Aswath Damodaran

20

Final  twist:  Disney  in  2013  

¨  Disney  did  return  to  holding  cash  between  2008  and  
2013,  with  dividends  and  buybacks  amounRng  to  $2.6  
billion  less  than  the  FCFE  (with  a  target  debt  raRo)  over  
this  period.    
¨  Disney  conRnues  to  earn  a  return  on  capital  well  in  
excess  of  the  cost  of  capital  and  its  stock  has  doubled  
over  the  last  two  years.  
¨  Now,  assume  that  Bob  Iger  asks  you  for  permission  to  
withhold  even  more  cash  to  cover  future  investment  
needs.  Are  you  likely  to  go  along?  
a.  Yes  
b.  No  

Aswath Damodaran

21

Case  2:  Vale  –  Dividends  versus  FCFE  

 
Aggregate
Average

Net Income
$57,404
$5,740

Dividends
$36,766
$3,677

Dividend Payout Ratio
$1
$1

Stock Buybacks
$6,032
$603

Dividends + Buybacks
$42,798
$4,280

Cash Payout Ratio
$1
 

Free CF to Equity (pre-debt)
($1,903)
($190)

Free CF to Equity (actual debt)
$1,036
$104

Free CF to Equity (target debt ratio)

$19,138
$1,914

Cash payout as % of pre-debt FCFE

FCFE negative

 
Cash payout as % of actual FCFE
4131.08%
 

Cash payout as % of target FCFE
223.63%
 

Aswath Damodaran

22

Vale:  Its  your  call..  

¨  Vale’s  managers  have  asked  you  for  permission  to  cut  dividends  
(to  more  manageable  levels).  Are  you  likely  to  go  along?  
a.  Yes  
b.  No  
¨  The  reasons  for  Vale’s  dividend  problem  lie  in  it’s  equity  
structure.  Like  most  Brazilian  companies,  Vale  has  two  classes  of  
shares  -­‐  common  shares  with  voRng  rights  and  preferred  shares  
without  voRng  rights.  However,  Vale  has  commioed  to  paying  out  
35%  of  its  earnings  as  dividends  to  the  preferred  stockholders.  If  
they  fail  to  meet  this  threshold,  the  preferred  shares  get  voRng  
rights.  If  you  own  the  preferred  shares,  would  your  answer  to  the  
quesRon  above  change?  
a.  Yes  
b.  No  

Aswath Damodaran

23

 Mandated  Dividend  Payouts  
24

¨  Assume  now  that  the  government  decides  to  mandate  a  

minimum  dividend  payout  for  all  companies.  Given  our  
discussion  of  FCFE,  what  types  of  companies  will  be  hurt  
the  most  by  such  a  mandate?  
a.  Large  companies  making  huge  profits  
b.  Small  companies  losing  money  
c.  High  growth  companies  that  are  losing  money  
d.  High  growth  companies  that  are  making  money  
¨  What  if  the  government  mandates  a  cap  on  the  dividend  
payout  raRo  (and  a  requirement  that  all  companies  
reinvest  a  porRon  of  their  profits)?  
Aswath Damodaran

24

 Case  3:  BP:  Summary  of  Dividend  Policy:  
1982-­‐1991  
25

Summary of calculations

Average
Standard Deviation
Maximum
Minimum

Free CF to Equity
$571.10
$1,382.29
$3,764.00
($612.50)

Dividends
$1,496.30
$448.77
$2,112.00
$831.00

Dividends+Repurchases
$1,496.30
$448.77
$2,112.00
$831.00

Dividend Payout Ratio

84.77%

Cash Paid as % of FCFE
262.00%

ROE - Required return

-1.67%
11.49%
20.90%
-21.59%

Aswath Damodaran

25

 BP:  Just  Desserts!  
26

Aswath Damodaran

26

 Managing  changes  in  dividend  policy  
27

Aswath Damodaran

27

 Case  4:  The  Limited:  Summary  of  Dividend  
Policy:  1983-­‐1992  
28

Summary of calculations

Average
Standard Deviation
Maximum
Minimum

Free CF to Equity
($34.20)
$109.74
$96.89
($242.17)

Dividends
$40.87
$32.79
$101.36
$5.97

Dividends+Repurchases
$40.87
$32.79
$101.36
$5.97

Dividend Payout Ratio

18.59%

Cash Paid as % of FCFE
-119.52%

ROE - Required return

1.69%
19.07%
29.26%
-19.84%

Aswath Damodaran

28

 Growth  Firms  and  Dividends  
29

¨  High  growth  firms  are  someRmes  advised  to  iniRate  

dividends  because  its  increases  the  potenRal  
stockholder  base  for  the  company  (since  there  are  
some  investors  -­‐  like  pension  funds  -­‐  that  cannot  buy  
stocks  that  do  not  pay  dividends)  and,  by  extension,  
the  stock  price.  Do  you  agree  with  this  argument?  
a.  Yes  
b.  No  

¨  Why?  

Aswath Damodaran

29

 5.  Tata  Motors  

 
Aggregate
Average

Net Income
$421,338.00
$42,133.80

Dividends
$74,214.00
$7,421.40

Dividend Payout Ratio
17.61%
15.09%

Stock Buybacks
$970.00
$97.00

Dividends + Buybacks
$75,184.00
$7,518.40

Cash Payout Ratio
17.84%

 
Free CF to Equity (pre-debt)
($106,871.00)
($10,687.10)

Free CF to Equity (actual debt)
$825,262.00
$82,526.20

Free CF to Equity (target debt ratio)
$47,796.36
$4,779.64

Cash payout as % of pre-debt FCFE
FCFE negative

Cash payout as % of actual FCFE
9.11%

Cash payout as % of target FCFE
157.30%

Negative FCFE, largely

because of acquisitions.

Aswath Damodaran

30

 Summing  up…  
31

Quality of projects taken: ROE versus Cost of Equity

Poor projects Good projects

Baidu
Cash Surplus Cash Surplus + Good
Cash Surplus + Poor
Dividends paid out relative to FCFE

Projects Projects
Significant pressure to Maximum flexibility in
pay out more to setting dividend policy
stockholders as
dividends or stock
buybacks

Deutsche Bank Disney

Cash Deficit

Cash Deficit + Poor Cash Deficit + Good

Projects Projects
Cut out dividends but Reduce cash payout, if
real problem is in any, to stockholders
investment policy.
Vale Tata Mtrs

Aswath Damodaran

31

 6 ApplicaRon  Test:  Assessing  your  firm’s  
dividend  policy  
32

¨  Compare  your  firm’s  dividends  to  its  FCFE,  looking  at  
the  last  5  years  of  informaRon.  

¨  Based  upon  your  earlier  analysis  of  your  firm’s  project  
choices,  would  you  encourage  the  firm  to  return  more  
cash  or  less  cash  to  its  owners?  

¨  If  you  would  encourage  it  to  return  more  cash,  what  
form  should  it  take  (dividends  versus  stock  buybacks)?  

Aswath Damodaran

32

II.  The  Peer  Group  Approach    

¨  In  the  peer  group  approach,  you  compare  your  

company  to  similar  companies  (usually  in  the  same  
market  and  sector)  to  assess  whether  and  if  yes,  
how  much  to  pay  in  dividends.  

    Dividend  Yield   Dividend  Payout  

Company   2013   Average  2008-­‐12   2013   Average  2008-­‐12   Comparable  Group   Dividend  Yield   Dividend  Payout  
Disney   1.09%   1.17%   21.58%   17.11%   US Entertainment
0.96%   22.51%  
Global Diversified
Mining & Iron Ore
Vale   6.56%   4.01%   113.45%   37.69%   (Market cap> $1 b)
3.07%   316.32%  
Global Autos (Market
Tata  Motors   1.31%   1.82%   16.09%   15.53%   Cap> $1 b)
2.13%   27.00%  
Global Online
Baidu   0.00%   0.00%   0.00%   0.00%   Advertising
0.09%   8.66%  
Deutsche  Bank   1.96%   3.14%   362.63%   37.39%   European Banks
1.96%   79.32%  

Aswath Damodaran

33

 A  closer  look  at  Disney’s  peer  group  
34

Market Dividends + Net Dividend Dividend Cash

Company Cap Dividends Buybacks Income FCFE Yield Payout Return/FCFE
The Walt Disney Company $134,256 $1,324 $5,411 $6,136 $1,503 0.99% 21.58% 360.01%
Twenty-First Century Fox, Inc. $79,796 $415 $2,477 $7,097 $2,408 0.52% 6.78% 102.87%
Time Warner Inc $63,077 $1,060 $4,939 $3,019 -$4,729 1.68% 27.08% NA
Viacom, Inc. $38,974 $555 $5,219 $2,395 -$2,219 1.42% 23.17% NA
The Madison Square Garden Co. $4,426 $0 $0 $142 -$119 0.00% 0.00% NA
Lions Gate Entertainment Corp $4,367 $0 $0 $232 -$697 0.00% 0.00% NA
Live Nation Entertainment, Inc $3,894 $0 $0 -$163 $288 0.00% NA 0.00%
Cinemark Holdings Inc $3,844 $101 $101 $169 -$180 2.64% 63.04% NA
MGM Holdings Inc $3,673 $0 $59 $129 $536 0.00% 0.00% 11.00%
Regal Entertainment Group $3,013 $132 $132 $145 -$18 4.39% 77.31% NA
DreamWorks Animation SKG Inc. $2,975 $0 $34 -$36 -$572 0.00% NA NA
AMC Entertainment Holdings $2,001 $0 $0 $63 -$52 0.00% 0.00% NA
World Wrestling Entertainment $1,245 $36 $36 $31 -$27 2.88% 317.70% NA
SFX Entertainment Inc. $1,047 $0 $0 -$16 -$137 0.00% NA NA
Carmike Cinemas Inc. $642 $0 $0 $96 $64 0.00% 0.00% 0.27%
Rentrak Corporation $454 $0 $0 -$23 -$13 0.00% NA NA
Reading International, Inc. $177 $0 $0 -$1 $15 0.00% 0.00% 0.00%
Average $20,462 $213 $1,083 $1,142 -$232 0.85% 41.28% 79.02%
Median $3,673 $0 $34 $129 -$27 0.00% 6.78% 5.63%

Aswath Damodaran

34

 Going  beyond  averages…  Looking  at  the  market  
35

¨  Regressing  dividend  yield  and  payout  against  expected  growth  

across  all  US  companies  in  January  2014  yields:  
 

PYT  =  Dividend  Payout  RaRo  =  Dividends/Net  Income  

YLD  =  Dividend  Yield  =  Dividends/Current  Price  
BETA  =  Beta  (Regression  or  Booom  up)  for  company  
EGR  =  Expected  growth  rate  in  earnings  over  next  5  years  (analyst  esRmates)  
DCAP  =  Total  Debt  /  (Total  Debt  +  Market  Value  of  equity)  

Aswath Damodaran

35

 Using  the  market  regression  on  Disney  
36

¨  To  illustrate  the  applicability  of  the  market  regression  in  analyzing  
the  dividend  policy  of  Disney,  we  esRmate  the  values  of  the  
independent  variables  in  the  regressions  for  the  firm.  
¤  Beta  for  Disney  (booom  up)      =  1.00  
¤  Disney’s  expected  growth  in  earnings  per  share  =  14.73%  (analyst  
esRmate)  
¤  Disney’s  market  debt  to  capital  raRo    =  11.58%    
¨  SubsRtuRng  into  the  regression  equaRons  for  the  dividend  payout  
raRo  and  dividend  yield,  we  esRmate  a  predicted  payout  raRo:  
¤  Predicted  Payout  =  .649  –  0.296  (1.00)-­‐.800  (.1473)  +  .300  (.1158)  =  .2695    
¤  Predicted  Yield  =  0.0324  –  .0154  (1.00)-­‐.038  (.1473)  +  .023  (.1158)  =    .0140    
¤  Based  on  this  analysis,  Disney  with  its  dividend  yield  of  1.09%  and  a  
payout  raRo  of  approximately  21.58%  is  paying  too  liole  in  
dividends.  This  analysis,  however,  fails  to  factor  in  the  huge  stock  
buybacks  made  by  Disney  over  the  last  few  years.    

Aswath Damodaran

36

 The  Big  Picture…  
37

Maximize the value of the business (firm)

The Investment Decision The Financing Decision The Dividend Decision

Invest in assets that earn a Find the right kind of debt If you cannot find investments
return greater than the for your firm and the right that make your minimum
minimum acceptable hurdle mix of debt and equity to acceptable rate, return the cash
rate fund your operations to owners of your business

The hurdle rate The return How much How you choose
should reflect the The optimal The right kind
should reflect the cash you can to return cash to
riskiness of the mix of debt of debt
magnitude and return the owners will
investment and and equity matches the
the timing of the depends upon depend on
the mix of debt maximizes firm tenor of your
cashflows as welll current & whether they
and equity used value assets
as all side effects. potential prefer dividends
to fund it. investment or buybacks
opportunities

Aswath Damodaran

37