Dividend policy of Confidence Cement Limited Report On Dividend Policy of Confidence Cement Limited Submitted to: Dr. Mahmood Osman Imam Chairman Department of Finance University of Dhaka University of Dhaka December 25, 2008 25. 12. 2008 Dr. Mahmood Osman Imam Chairman Department of Finance University of Dhaka Dhaka Executive Summary Chapter15 Introduction5 1. 1Company Profile in Brief5 Basis of Accounting5 1. 2 b ackground of the study6 1. 3 Objective6 1. 5 Methodology7 1. 6 Limitations7 Chapter 27 2. 1 Dividend policy of a firm7 2. 2 Dividend relevance:8 2. 3 Dividend irrelevance:8 2. Different Types of dividend9 2. 5 Different types of dividend policy10 2. 6 diuviudend as a signal about firm’s performance:11 Chapter 311 Dividend Policy of Confidence Cement Limited11 3. 1 Financial Performance and Dividend Payout12 3. 2 Earnings per share and dividend12 Fig. 1. Comparison between EPS and DPS13 Fig. 2. Comparison between Payout and Growth14 Fig3: OCF, FCF and dividend per share15 Fig4: Changes in stock price16 Fig5: Growth and DPS17 3. 3 Implications17 Fg6:P/E ratio of Confidence Cement Limited17 Fig7: Net Asset Value per Share18 Chapter 418 4. 1 Stock dividend per share18 . 2 Findings19 4. 3 Recommendations19 Conclusion19 Executive Summary Paying out dividends belongs to the easiest way to communicate financial well-being and shareholder value, since they are sending out a powerful message about future prospects and performances. The willingness, and also the ability of companies to pay out steady dividends and may be even to increase them, provides the shareholder with valuable about the company fundamentals. There is the opinion of some financial analysts that a dividend policy is irrelevant because investors have the ability to create homemade dividends.
That can be done by adjusting the personal portfolio to reflect the investor’s own preferences. A second argument suggests that little to no dividend payout is more favorable for the share price to go up. At Confidence Cement Ltd. the company has a tendency to pay a regular cash dividend based on the earnings. In 2004, in spite of incurring loss; it still paid a dividend of 5%. The company had always paid cash dividends. Stock dividend had never been paid. Paid up capital of the company is only 38% of the authorized capital.
After analyzing the annual reports of 2003, 2004, 2005 and 2006, it has been revealed that the company had adopted a dividend policy showing the tendency of a stable one. It is an indication of the management’s concern towards attracting the investors. Payout ratio of the company shows a steady trend in 2005, 2006, and 2007. Earnings per Share (EPS) in recent years are growing at a faster rate than the previous ones. The company’s overall growth rate is increasing. Both Free Cash Flow (FCF) and Operating Cash Flow (OCF) is showing a slightly downward trend.
Net Asset Value (NAV) has remained more or less constant over the last 8 years. Chapter1 Introduction Dividend policy refers to the policy chalked out by companies regarding the amount it would pay to their shareholders as dividend. With profit making comes the question of utilizing the profit gainfully. The company has two options with them: They can retain these profits within the company. They can pay this profit in form of dividend to the shareholders. The dividend policy t o be adopted by the company is based on this two options.
Once this is sorted out, a permanent dividend policy can be put into place. This policies shape the attitude of the investors and the financial market in general towards the concerned company. The policies are decided according to the current and future financial positions of the company. The preference and orientation of the investors are also taken into account. Corporate dividend policies exhibit very clear tendencies. In particular, dividends are “smoothed”, dividends are rarely decreased, and investors react positively to dividend increase and negatively to dividend decreases.
While these facts are well-established, the economic mechanism behind these facts, that is, how and why firms decide about a particular dividend policy are the major questions on which the report is based on. Depending on the different parameters which take an effect on the dividend policy of the firm, the study finds the aspects adopted by Confidence Cement Ltd. 1. 1Company Profile in Brief |Confidence Cement Limited (CCL) is the first private sector cement manufacturing company in Bangladesh established in early 90’s with having | |4,80,000 M/T annual production capacity at Chittagong, 16 K.
M away from Chittagong port, besides Dhaka Chittagong highway. CCL is the first | |ISO-9002 certified cement manufacturing in Bangladesh. It has a unique management system in quality Assurance, Marketing, Sales, and | |Procurements. It manufactures ordinary Portland cement. Our company aims to be the number one cement manufacturing company in Bangladesh, through| |continuous development and by producing high & consistent quality cement to meet all customers requirement at all time.
To achieve these | |objectives CCL uses modern machineries, calibrated testing equipment’s, computerized packing & raw materials mixing devices in its production | |process. Additionally the company frequently arranges internal & external training program for the staff of all level to develop the potentiality| |and skill of its human resources. CCL is always keen to keep the customers satisfied by proving the best possible service. | The company was incorporated as a Public Limited Company on May 2, 1991 with an authorized capital of tk. 00,000,000 divided into 2000000 thousand ordinary shares of tk. 100 each which was increased of tk. 500000000 on 31 March,1998. Basis of Accounting The accounts have been prepared in accordance with the relevant requirements of the Securities & Exchange Commission Exchange rules 1987 and the Companies Act 1994, following consistent and generally accepted accounting principles under the historical cost convention excepting revaluation of fixed assets acquired and financed by long term foreign currency loans. 1. Scope of the study
The scope of this report is limited to Dividend Policy adopted by Confidence Cement Limited with an insight to overall performance of the company. 1 Background of the study The report is prepared as a fulfillment of partial requirement of the term paper on Dividend Policy of Confidence Cement Limited. Mr. Mahmood Osman Imam, Professor of Finance and honorable course teacher, has assigned the task of writing this report as a part of individual presentation on Dividend policy. 1. 3 Objective ? EPS and DPS Comparison of Confidence Cement Limited. Correlation between Payout ratio and Growth rate of the company. ? Trend of changing Market Price of the company’s Share. ? Scenario of P/E Ratio of the company. ? Net Asset Value per Share of the company. ? Comparison of Free Cash Flow and Operating Cash Flow of the company ? Prospects of the company in the light of Dividend policy. The main objective of the study is to find out and critically evaluate the dividend pattern of Confidence Cement Bangladesh Ltd. Dividend trend over the last 5 years have been analyzed and the category of dividend policy has been found out. . 5 Methodology Company financial information was the main tool in finding out the relevant information. Company annual report is analyzed and balance sheet, profit and loss account, statement of cash flow was the main statements from where information was collected. Earnings per share, cash dividend per share, stock dividend per share, operating cash flow per share, and free cash flow per share were used as the main tools to find out the dividend policy of the firm. 1. 6 Limitations The study had certain limitations which include unavailability of some data.
This was due to the reluctance of the company to disclose some information. Chapter 2 2. 1 dividend policy of a firm In theory, the object of a dividend policy should be to maximize a shareholder’s return so that the value of investment is maximized. Shareholder’s return consists of two component dividends and capital gains. Dividend policy has a direct influence on these two components of return. Let us consider an example to highlight the issues underlying the dividend policy payout ratio—which is dividend as a percentage of earnings are an important concept vise-a -vise the dividend policy.
A high payout policy means more current dividends and less retained earnings, which may consequently result in slower growth and perhaps lower market price per share. Low payout policy means less current dividends, more retained earnings and higher capital gains and perhaps higher market price per share. Capital gains are future earnings while dividends are current earnings. Dividends in most countries are taxed more than capital gains. Therefore, it is quite plausible that some investors would prefer high payout companies while other may prefer low payout companies. Paying dividend involves outflow of cash.
The cash available for the payment of dividends is affected by the firm’s investments and financing decisions. A decision to incur capital expenditure implies that less cash will be available for the payment of dividends. Thus, investment decision affects dividend decision. If the firm’s value is affected, is it because of the investment decision or the dividend decision? Given the firm’s capital expenditure, and that it does not have sufficient internal funds to pay dividends, it can raise funds by issuing new shares. In this case, the dividend decision is not separable from the firm’s financing decision. . 2 Dividend relevance: Professors James E Walter argues that the choice of dividend policies almost always affect the value of the firms. His model, one of the earlier theoretical works, shows the importance of the relationship between the firm’s rate of return, r, and its cost of capital, k, in determining the dividend policy that will maximize the wealth of shareholders. 2. 3 Dividend Irrelevance: According to Miller and Modigliani (MM), under a perfect market situation, the dividend policy of a firm is irrelevant, as it does not affect the value of the firm.
They argue that the value of the firm depends on the firm’s earnings that result from its investment policy. Thus, when investment decision of the firm is given, dividend decision – the split of the earnings between dividends and retained earnings – is of no significance in determining the value of the firm. A firm operating in perfect capital market conditions may face one of the following three conditions regarding the payment of dividends: ? The firm has sufficient cash to pay dividends. ? The firm does not have sufficient cash to pay dividends and therefore, it issues new shares to finance the payment of dividends. The firm does not pay dividends but a shareholder needs cash. In the first situation, when the firm pays dividends, shareholders get cash in their hands but the firm’s assets reduce. Thus, there is a transfer of wealth from shareholders’ one pocket to their another pocket causing no change in the firm’s value. In the second situation, when the firm issues new shares to finance the payment of dividends, two transactions take place. First, the existing shareholders get cash in the form of dividends, but they suffer an equal amount of capital loss since the value of their claim on assets reduces.
Thus wealth of shareholders does not change. Second, the new shareholders part with their cash to company in exchange for new shares at a fair price per share. The fair price per share is share price before the payment of dividends less dividend per share to the existing shareholders. The existing shareholders transfer a part of their claim to the new shareholders in exchange of cash. There is no net gain or loss. Both transactions are fair and thus the value of the firm will remain unaltered after this transaction.
In the third situation, if the firm does not pay any dividend a shareholder can create a “home made dividend” by selling a part of his share at the market price in the capital market for obtaining cash. The shareholder will have less number of shares. He or she has exchanged a part of his claim on the firm to a new shareholder for cash. The net effect is same as in the cash of second situation. The transaction is a fair transaction, and no one loses or gains. The value of the firm remains the same and no one looses or gains. The value of the firm remains the same, before or after these transactions. . 4 Different Types of Dividends: There are three types of dividends namely as (i) Cash dividend (ii) Stock dividend and (iii) Dividend in kind in the form of gift, transport costs etc. The term dividend usually refers to cash distribution of earnings. If the distribution is made from sources other than current or accumulated retained earnings, the term distribution rather than dividend is used. The most common type of dividend is in the form of cash. Public companies usually pay regular cash dividends four times in a year. Sometimes firms will pay regular cash dividend and an extra cash dividend.
Paying a cash dividend reduces the corporate cash and retained earnings shown in the balance sheet – expect in the case of liquidating dividend. Another type of dividend is paid out in shares of stock. The dividend is referred to as a stock dividend. It is not a true dividend, because no cash leaves the firm. Rather, a stock dividend increases the number of shares outstanding, thereby reducing the value of each share. A stock dividend is commonly expressed as a ratio, for example with a 2% stock dividend a shareholder receives one new share for every 50 current owned.
When a firm declares a stock split, it increases number of share outstanding. Because each share is now entitled to a similar percentage of the firm’s cash flow, the stock price would fall. For example, if the manager of a firm whose stock is selling at $90 declare a 3(1 stock split, the price of a share of stock should fall to about $30. A stock split strongly resembles a stock dividend except it is usually much larger. 2. 5 Different Types of Dividend Policies: There are four types of dividend policies. They are as follows:
Sticky Dividend Policy: The dividend policy in which a fixed amount of cash is paid as dividend every year. Constant Payout Policy: The dividend is paid in such a way that the ratio of DPS to EPS remains constant over the years. Stable Dividend Policy: In this policy dividend is being smoothened steadily with the streamline of growth of the company. Residual Dividend Policy: Under this policy, dividend is considered to be payable only when there is any residual amount after paying all the claimants and possible investments. 2. Dividend as a Signal about firm’s future performance: ? Unexpected increase of dividend is a signal of good news as perceived by the investors. ? Managers are concerned about the change of dividend trends. ? When change of dividend is positive, it gives a positive signal and causes a rise in share price. ? When change of dividend is negative, it gives a negative signal and causes a fall in share price. ? When no change of dividend, it gives no signal, neither positive nor negative at all. ? Managers increase dividends only when there is increase in earnings and such increase is sustainable in the long- run. Managers cut dividends only when they are faced to cut it. ? Managers smoothen dividends. Chapter 3 Dividend Policy of Confidence Cement Limited Dividend policy of Confidence Cement Limited is analyzed based on the basic fianancial data of the compan 3. 1 Financial Performance and Dividend Payout |Year End |EPS |DPS | |Note: | | | | |Growth, g = ROE or EPS/100 *(1-Payout) | | | | | | | | |Free cash flow = cash low from operation minus capital expenditure | | | | | | | | |and dividend. | | | | | | | | | | | | | | | | | 3. 2 Earnings per share and dividend If we take a glance at the above data on dividend per share and Earnings per share, it becomes evident that the company maintained a dividend policy which is developed with respect to the earnings available.
Initially, at 1999 and 2000, earnings per share were tk. 78 and tk. 84 respectively and there was an increasing trend. The company declared a dividend of 30% at both of these years. After this period, there was a sharp decline in the company earnings of 275%, i. e, the company suffered loss. And no dividend was declared. In 2003 earnings increased significantly. And the company declared a dividend of 5%. Next year though earnings were negative, the company maintained the dividend of 5%. In 2005, 2006 and 2007, there was an increase in earnings.
And the company also increased the dividend from 5% in 2005 to 15% in 2006 and 2007. The problem with this dividend 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 be adversely affected. [pic] Fig1: Comparison between EPS and Dividend Fig. 1. Comparison between EPS and DPS [pic] Fig. 2. Comparison between Payout and Growth 3. 3 Operating cash flow (OCF) and Free Cash Flow (FCF)
Operating cash flow for the cash flow from the year 2000 to 2007 is shown below: Operating cash flow is found in the company cash flow statement. Free cash flow = cash flow from operation minus capital expenditure and dividend. |Year |2003 |2004 |2005 |2006 |2007 | |OCF |90466374 |-19724070 |-49486068 |165505376 |25828612 | |OCF/share |47. |-10. 4 |-26 |87 |13. 5 | |FCF | – |-11492887 |-81854097 |119776000 |18282956 | |FCF/share | – | -6 | -43 | 63 | 9. 6 | |Dividend per share | 5 | 5 | 5 | 15 | 15 | [pic]
Fig3: OCF, FCF and dividend per share The bar diagrams show the direct relation of FCF per share and OCF per share in deciding the company dividend policy. It can be seen quite clearly that whenever the company could not generate sufficient cash flow, dividend payout was affected, because confidence Cement Ltd. has maintained over the years a constant payout dividend policy. [pic] Fig4: Changes in stock price [pic] Fig5: Growth and DPS 3. 3 Implications Growth of the company showed a sharp decline 2002-2004 and in 2006 and 2007 it shows some sign of increase.
Dividend has also increased over the last two years. But this kind of dividend policy has a certain disadvantage. If growth of the company declines in the future, the company may not be able to maintain the stable dividend and subsequently stock price will suffer. It can be traced out from the diagrams that the company always had the tendency to maintain a stable dividend policy, because the management believes that dividend serves as a signal to the market and which in turn increases share price. [pic]
Fg6:P/E ratio of Confidence Cement Limited [pic] Fig7: Net Asset Value per Share Chapter 4 4. 1 Stock dividend per share The company paid no stock dividend as it is found in the company financial information from Years 2000 to 2007. This is an indication that the company wants to smoothen dividend as it Has a direct impact on the price of the outstanding shares. The company is more interested in paying cash dividend because the management assumes that the investors want quick return on their investments. . 2 Findings The dividend policy acts as a signal for investors for gauging the future earning possibilities as expected by the management of the company. The dividend policies are directed towards attracting investors to their company. This is termed as the clientele effect. The firms that hold back free cash flows are lesser in value than those firms, which allow free cash flows and pay dividends from them. There are quite a few impediments to companies paying dividends to their shareholders.
Throughout the last five years, Confidence Cement Ltd. maintained a stable dividend policy Analyzing the EPS, OCF per share, FCF per share, nav per share it can be summarized that the company has a tendency to maintain a stable dividend payout to the shareholders. in line of the earnings of the company. The management believes that a stable dividend policy will serve as a mechanism for market signaling the shareholders and as a result, share price will go up. As a consequence, investors will be encouraged. 4. 3 Recommendations
The problem with the dividend policy adopted by the company 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 be adversely affected. The company tries to give a portion of the earnings as dividend which in turn increases the expectation of the investors. Confidence Cement Limited should be more concerned with the earnings growth than high dividend payout. Conclusion
Once a company makes a profit, they must decide on what t o do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. Once the company decides on whether to pay dividends, they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets. What they decide depends on the situation of the company now and in the future. It also depends on the preferences of investors and potential investors.
Firm performance greatly depends on the dividend policy. Confidence cement ltd. gives high emphasis on their dividend policy. The company has a goal to maintain a steady dividend policy. Dividend policy of this kind serves as a signal to the shareholders of future growth. As a result, this company has to pay a minimum level of dividend to the shareholders. Dividend irrelevance theory purports that a firm’s dividend policy has n effect on either its value or its cost of capital. Investors value dividends and capital gains equally.
Optimal dividend policy proponents believe that there is a dividend policy that strikes a balance between current dividends and future growths that maximizes the firm’s stock price. Dividend Relevance theory suggests that the value of the firm is affected by its dividend policy. The optimal dividend policy is the one maximizes the firm value. The management of Confidence Cement Ltd. believes ion the optimal dividend policy. As shareholders get a steady amount of dividend in the line of the earnings of the company, they tend to invest more for the company share. As a result, firm value increases.
