impact of dividend on stock prices

Impact of Dividend on Stock Prices i

THESIS

TOPIC

“IMPACT OF DIVIDEND ON STOCK PRICES”

UNDER THE GUIDANCE OF:

Mr. HARISH PATELASSISTANT MANAGERBAJAJ CAPITAL LTD

SUBMITTED BY:

AVINASH KHANDELWALPGP/FW/2005-07

Impact of Dividend on Stock Prices ii

ABSTRACT

The project aims to establish the impact of dividend on market price of a share.

This has been done for individual companies in Steel sector.

After studying the basic concepts of dividends and dividend policy I am able to

get a proper perspective of the requirements of the project and also gain a better

understanding of the results obtained. I have looked to find the relation between

pre dividend price change and the dividend using regression analysis. Similarly, I

have analyzed the relation between the post dividend price change and the

dividend.

It is a matter of fact that dividends are declared by a company primarily to

generate capital and also at certain times to maintain the market sentiment. It is

in the best interests of the company to maximize the market value of its share

and companies use dividend as a tool to maintain their corporate image.

However, the degree of correlation between the dividend and the market price is

low which implies that several other internal and external factors affect the

market value of shares.

To gain a holistic picture, I also did a comparative study of two peers in a sectors

to better understand how the specific requirements of each sector also impact

the dividend policy of a company.

The conclusions derived from the analysis performed further consolidated

theoretical knowledge and deviations were better understood.

Impact of Dividend on Stock Prices iii

THESIS SYNOPSIS

Thesis Topic:

“Impact of Dividend on Stock Prices”

IntroductionThe term "dividend" usually refers to a cash distribution of earnings. It is nothing

but a part of profit (earning per share) which company decides to share with its

shareholders in form of cash on a regular basis, usually annually (sometimes

semiannually). Once a company makes a profit, they must decide on what to 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.

My study is all about the DIVIDENDS and its effect on the price fluctuations of

the stock, i.e. how individual investor perceives dividends and how corporate

world perceive their payouts. The controversy is that there are two school of

thoughts with respect of Dividends, one shows that dividends has no effect on

market pricing and other explains that how dividends positively influence the

market pricing of particular stock.

ObjectiveThe Primary objective is to study all about DIVIDENDS and its effect on the price

fluctuation of the stock. Tried to explore the payout mechanism and tried to

Impact of Dividend on Stock Prices iv

scrutinize the consequence on stock pricing with respect to dividend paid by the

companies.

The Secondary objective is to understand why dividends are used by some

companies and not by others.

Methodology

Once understanding the topic and the objectives of the thesis, the proceedings of

thesis would involve secondary research. Secondary research would include

analysis from newspapers, journals, research papers in this field and also

reference of books and websites related to this topic. Once the data compilation

is over, the data would be analyzed followed by the recommendations and

conclusion.

Draft Report FormulationAfter data is analyzed and interpretation is done a draft report will be formulated

in order to get validation from the mentor for the final report. All aspects will be

checked and in order to have an errors free report.

Final Report FormulationAfter all the errors are removed and the draft report gets a clearance from the

guide, the final report will be formulated for the final submission.

Impact of Dividend on Stock Prices v

ACKNOWLEDGEMENT

No task can be achieved alone. It took many special people to facilitate it and

support it. Hence, I would like to acknowledge all for their valuable support and

convey my humble gratitude to them.

Last but not the least, I would like to thank Mr Harish Patel, Assistant Manager-

IBG (BAJAJ CAPITAL, Mumbai) who spared his valuable time in imparting

relevant information without which the study would have never been completed. I

am very thankful to all who helped me throughout my thesis and have shown the

right way that we say the LIGHT OF THE DAY.

Impact of Dividend on Stock Prices 1

TABLE OF CONTENTS

TOPICS PAGE NO.

Chapter: 1 1-38

a) Introduction

- Background on Dividends- Important dates- Types of dividends - Some facts about dividend policy

b) Dividend Policies

- Measures of Dividend Policy- Factors that determine the dividend policy- How Do Firms View Dividend Policy- Summary of Factors That Could Affect Dividend Policy- Dividend-Paying Methods

c) Impact of dividends

- Arguments against dividends- Arguments for dividends

d) Ideal time to pay dividend

e) Dilemma: Should the firm use retained earnings

f) Stock Dividends and Stock Splits

g) Three Schools Of Thought on Dividends

h) Dividend policy and share value - Four models

Chapter: 2 39-50

Indian Steel Industrya) Overviewb) SWOT Analysisc) Future of Indian Steel Industry


Chapter: 3 51-54

a) Sectors Chosenb) Assumptions

Chapter: 4 55-59

Historical Data

Chapter: 5 60-66

Analysis

Chapter: 6 67-71

a) Conclusionb) Recommendationc) Limitations

Chapter: 7 72-73

Bibliography

Chapter: 8 74-76

Annexure


LIST OF FIGURES & TABLES

Topics Page No

1) Dividend changes: publicly owned firm-1981-1990 12

2) India’s crude steel production (MT) historic trends 40

3) Apparent Finished Steel Consumption (mT) 41

4) Finished Steel Production 2005-06 41

5) Sail’s Growth Plans 47

6) Projected per Capita consumption of Finished Steel in India (kg) 49

7) Growth Scenarios 49

8) Historical Scrip-wise Price Volume Data 56


Chapter 1


INTRODUCTION

There are many reasons for paying dividends and there are many reasons for not

paying any dividends. As a result, `dividend policy' is controversial.

The term "dividend" usually refers to a cash distribution of earnings. It is nothing

but a part of profit (earning per share) which company decides to share with its

shareholders in form of cash on a regular basis, usually annually (sometimes

semiannually). My study is all about the DIVIDENDS and its effect on the price

fluctuations of the stock, i.e. how individual investor perceives dividends and how

corporate world perceive their payouts. The controversy is that there are two

school of thoughts with respect of Dividends, one shows that dividends has no

effect on market pricing and other explains that how dividends positively

influence the market pricing of particular stock.

In U.S, earnings are doubled taxed i.e. firstly company pays the corporate tax on

its earnings and secondly when the same amount is distributed among the

members it is taxed as their personal income. The rate of tax in U.S on capital

gain is less than income from dividends. Thus to avoid this double taxation,

generally investor are reluctant towards dividends and hold the shares for long

term prospective. But what if the dividends are not taxable in the hand of investor

and capital gains is taxable at higher rates than that of dividends, as in case of

India.

Taking these views, in Indian scenario, I have started this project, and tried to

explore the payout mechanism and tried to scrutinize the consequence on stock

pricing with respect to the dividends paid by the companies.

Why companies paying dividends is still a controversy. In Indian scenario if we

take some top traded 50 companies in Bombay Stock Exchange, there is hardly

any company which is not paying dividends, moreover a thorough study shows

that even those companies which were making losses, also paying some nominal


dividends, using their prior reserves (subject to The Companies (Transfer to

reserves) Rules -1975).

Wipro ltd is one of the renowned IT company in India but still if we compare the

stock price of Wipro and Infosys we find that Wipro is lagging behind owing to

conservative dividend policy (@ 25% continuously) unlike as Infosys

Technologies ltd, having an excellent payout (continuous growth in dividends).

The market risk of any security depends on its Beta, which shows the

relationship between the Sensex Returns and Security returns and measure the

relative risk associated with the security with respect to market. Higher the beta,

greater the risk associated with the security. Theoretically if the Beta of security

is less than one, the security will be affected lesser than proportion with market

Sensex.

The investors make equity investments with the expectation of capital gains

irrespective of whether they are short term or long term investors. Typically there

is no company, which can ensure capital gains to investors with out declaring

continuously dividends.

In other words the investors do care about dividends how ever small its impact

on their wealth. It’s not only the investors care about dividends, but also growth in

dividends and profitability of the companies in which they maid investments. The

technical analysis and the survey conducted amply prove this point. Unlike U.S

markets where treatment of tax is a major concern for the investors for accepting

dividends, Indian investors do not give greater weightage for the tax matters

since the dividends are taxed in the hands of the companies but not in the hands

of investors.


Background on Dividends

A dividend is a cash payment from a company's earnings, announced by a

company's board of directors and distributed among stockholders. In other

words, dividends are an investor's share of a company's profits, given to him or

her as a part-owner of the company. Aside from option strategies, dividends are

the only way for investors to profit from ownership of stock without eliminating

their stake in the company.

When a company earns profits from operations, management can do one of two

things with the profits. It can choose to retain them - essentially reinvesting them

into the company with the hopes of creating more profits and thus further stock

appreciation. The other alternative is to distribute a portion of the profits to

shareholders in the form of dividends. Management can also opt to repurchase

some of its own shares - a move that would also benefit shareholders.

A company must keep growing at an above-average pace to justify reinvesting in

itself rather than paying a dividend. Generally speaking, when a company's

growth slows, its stock won't climb as much, and dividends will be necessary to

keep shareholders around. This growth slowdown happens to virtually all

companies after they attain a large market capitalization. A company will simply

reach a size at which it no longer has the potential to grow at annual rates of 30-

40% like a small cap, regardless of how much money is plowed back into it. At a

certain point, the law of large numbers makes a mega-cap company and

outperforming growth rates which outperform the market an impossible

combination.

The changes witnessed in Microsoft in the last few years are a perfect illustration

of what can happen when a firm's growth levels off. In Jan 2003, the company

finally announced that it would pay a dividend: Microsoft had so much cash in the


bank that it simply couldn't find enough worthwhile projects in which to invest -

you can't be a high-flying growth stock forever!

The fact that Microsoft started to pay dividends did not signal the company's

demise; it simply indicated that Microsoft had become a huge company and had

entered a new stage in its life cycle, which meant it probably would not be able to

double and triple at the pace it once did.

Dividends Won't Mislead You

By choosing to pay dividends; management is essentially conceding that profits

from operations are better off being distributed to the shareholders than being put

back into the company. In other words, management feels that reinvesting profits

to try to achieve further growth will not offer the shareholder as high a return as a

distribution in the form of dividends.

There is another motivation for a company to pay dividends: a steadily increasing

dividend payout is viewed as a strong indication of a company's continuing

success. The great thing about dividends is that they can't be faked. They are

paid or not paid, increased or not increased.

This isn't the case with earnings, which are basically an accountant's best guess

of a company's profitability. All too often, companies must restate their past

reported earnings because of aggressive accounting practices, and this can

cause considerable trouble for investors, who may have already based future

stock price predictions on these (unreliable) historical earnings.

Expected growth rates are also unreliable. A company can talk a big game about

wonderful growth opportunities that will pay off several years down the road, but

there are no guarantees that it will make the most of its reinvested earnings.

When a company's robust plans for the future (which impact its share price

today) fail to materialize, your portfolio will very likely take a hit.


However, you can rest assured that no accountant can restate dividends and

take back your dividend check. Moreover, dividends can't be squandered away

by the company on business expansions that don't pan out. The dividends you

receive from your stocks are 100% yours. You can use them to do anything you

like: pay down your mortgage, spend it as discretionary income or buy the stock

of a company you think has better growth prospects.

Who Determines Dividend Policy?

The company's board of directors decides what percentage of earnings will be

paid out to shareholders, and then puts the remaining profits back into the

company. Although dividends are usually dispersed quarterly, it is important to

remember that the company is not obligated to pay a dividend every single

quarter. In fact, the company can stop paying a dividend at any time, but this is

rare, especially for a firm with a long history of dividend payments.

If people were used to getting their quarterly dividends from a mature company, a

sudden stop in payments to investors would be akin to corporate financial

suicide. Unless the decision to discontinue dividend payments was backed by

some kind of strategy shift, say investing all retained earnings into robust

expansion projects, it would indicate that something was fundamentally wrong

with the company. For this reason, the board of directors will usually go to great

lengths to keep paying at least the same dividend amount.

How Stocks That Pay Dividends Resemble Bonds

When assessing the pros and cons of dividend-paying stocks, you will also want

to consider their volatility and share price performance as compared to those of

outright growth stocks that pay no dividends.

Because public companies generally face adverse reactions from the


marketplace if they discontinue or reduce their dividend payments, investors can

be reasonably certain they will receive dividend income on a regular basis, for as

long as they hold their shares. Therefore, investors tend to rely on dividends in

much the same way that they rely on interest payments from corporate bonds

and debentures.

Since they can be regarded as quasi-bonds, dividend-paying stocks tend to

exhibit pricing characteristics that are moderately different from those of growth

stocks. This is because they provide regular income, similar to a bond, but still

provide investors with the potential to benefit from share price appreciation if the

company does well.

Investors looking for exposure to the growth potential of the equity market,

combined with the safety of the (moderately) fixed income provided by dividends,

should consider adding stocks with high dividend yields to their portfolio. A

portfolio with dividend-paying stocks is likely to see less price volatility than a

growth stock portfolio.

IMPORTANT DATES

There are four important dates to remember about dividends:

Declare Ex-div. Record Payment

dividend date date date

1) Declaration Date: the board of directors declares the dividend, determines

the amount of the dividend, and decides on the payment date.


2) Ex-Dividend Date: To receive the dividend, you have to buy the stock before

the ex-dividend date. On this date, the stock begins trading “ex-dividend” and

the stock price falls approximately by the amount of the dividend. This date

usually falls 2 – 4 days before the Record Date. This date allows for the

completion of all pending transactions, since it usually takes three days to settle

a regular stock sale. The Ex-Dividend Date is the most important date as far as

owning the stock if one wants to receive the dividend.

3) Date of Record: 4 days after the ex-dividend date, the firm receives the list

of stockholders eligible for the dividend.

Often, a bank trust department acts as registrar and maintains this list for the

firm.

4) Payment Date: This is the date the company mails the checks, often two

weeks or so after the record date.

On the Ex-Dividend Date, the market discounts stock’s price since the dividend is

no longer available to buyers.

TYPES OF DIVIDENDS

Dividends come in two types: fixed and variable. Dividends that pay at a fixed

rate go to owners of preferred stock, while variable dividends go to common

stock holders. There are also regular dividends, which are paid at regular

intervals (quarterly, semiannually or annually), or special dividends which are

paid in addition to the regular dividends.


The term "dividend" usually refers to a cash distribution of earnings. If it comes

from other sources, it is called "liquidating dividend". It mainly has the following

types:

RegularRegular dividends are those the company expects to maintain, paid quarterly

(sometimes monthly, semiannually or annually).

ExtraThose that may not be repeated.

SpecialThose that are unlikely to be repeated.

Stock DividendPaid in shares of stocks. Similar to stock splits, both increase the number of

shares outstanding and reduce the stock price.

CASH DIVIDENDS

Regular cash dividends are those paid out of a company’s profits to the owners

of the business (i.e., the shareholders). A company that has preferred stock

issued must make the dividend payment on those shares before a single penny

can be paid out to the common stockholders.

PROPERTY DIVIDENDS

A property dividend is when a company distributes property to shareholders

instead of cash or stock.

SPECIAL ONE-TIME DIVIDENDS


In addition to regular dividends, there are times a company may pay a special

one-time dividend. These are rare and can occur for a variety of reasons such as

a major litigation win, the sale of a business or liquidation of an investment. They

can take the form of cash, stock or property dividends. Due to the temporarily

lower rates of taxation on dividends, there has been an increase in special

dividends paid in recent years.

To add sugar to spice, there are times when these, special one-time dividends

are classified as a “return of capital”. In essence, these payments are not a

payout of the company’s profits but instead returns of money shareholders have

invested in the business. As a result, returns of capital dividends are tax-free.

INTERIM DIVIDENDSIt is a dividend declared part way through a company's financial year, authorized

solely by the directors. A dividend that is declared and paid before annual

earnings are determined. The amount of profit paid out by a company in

anticipation of the profit expected to be earned during a particular accounting

period.

LIQUIDATING DIVIDENDS

These are dividends that are paid in excess of the retained earnings that are

shown in the books of the company. They are viewed as a return on capital

rather than ordinary income. They are a distribution out of paid in capital when a

corporation permanently reduces its operations or winds up its affairs completely

i.e., it is the declared dividend in the closing of a firm to dispose off the assets of

the organization to qualified stockholders.

STOCK DIVIDENDSA stock dividend is a pro-rata distribution of additional shares of a company’s

stock to owners of the common stock. A company may opt for stock dividends for


a number of reasons including inadequate cash on hand or a desire to lower the

price of the stock on a per-share basis to prompt more trading and increase

liquidity (i.e., how fast an investor can turn his holdings into cash). Lowering the

price of the stock increases liquidity because on the whole, people are more

likely to buy and sell an Rs 250 stock than an Rs 5,000 stock; this usually results

in a large number of shares trading hands each day.

A stock split is, in essence, a very large stock dividend. In cases of stock splits, a

company may double, triple or quadruple the number of shares outstanding. The

value of each share is merely lowered; economic reality does not change at all.

REASONS FOR ISSUING SPLIT STOCK

LIQUIDITY

Some companies believe that their stock should be inexpensive so more people

can buy it. This creates a condition where more of the company's stock is bought

and sold (this is called "increased liquidity"). The problem, in theory, is that the

increased activity will also leads to bigger gains and drops in the stock, making it

more volatile.

Many investors believe splits are a good thing. They believe that the stock will

regain its original price. This is wrong. The stock is where it was...each share

now represents half of the equity in the company that it did before the split. That

means that each share is entitled to half the dividend, half the earnings, and half

of the assets that it once was.

http://beginnersinvest.about.com/cs/investing101/f/wtisstocksplit.htm


SOME FACTS ABOUT DIVIDEND POLICY

* Dividends are sticky; Firms are much more reluctant to cut dividends than increase them

Dividend Policies:

1) Constant Payout Ratio Policy: if directors declare a constant payout ratio

of, for example, 30%, then for every amount of earnings available to

stockholders, 30 cents would be paid out as dividends.

The ratio remains constant over time, but the money value of dividends changes

as earnings change.

2) Stable Rupee Dividend Policy: the firm tries to pay a fixed rupee dividend

each quarter.


Firms and stockholders prefer stable dividends. Decreasing the dividend sends

a negative signal.

3) Small Regular Dividend plus Year-End Extras: The firm pays a stable

quarterly dividend and includes an extra year-end dividend in prosperous years.

By identifying the year-end dividend as “extra,” directors hope to avoid signaling

that this is a permanent dividend

Measures of Dividend Policy

* Dividend Payout: measures the percentage of earnings that the company pays

in dividends

= Dividends / Earnings

* Dividend Yield: measures the return that an investor can make from dividends

alone

= Dividends / Stock Price

DIVIDEND PAYOUT RATIO

The percentage of net income that is paid out in the form of dividend is known as

the dividend payout ratio. This ratio is important in projecting the growth of

company because it’s inverse, the retention ratio (the amount not paid out to

shareholders in the form of dividends), can help project a company’s growth.

DIVIDEND YIELD

http://beginnersinvest.about.com/cs/investinglessons/l/blnetinc2common.htm


The dividend yield tells the investor how much he is earning on a common stock

from the dividend alone based on the current market price. Dividend yield is

calculated by dividing the actual or indicated annual dividend by the current price

per share.

FACTORS THAT DETERMINE THE DIVIDEND POLICY

Dividend policy of a firm depends largely on future needs for growth and

expansion. Firms which have substantial investment opportunities and

consequently considerable funding needs tend to keep their payout ratio low to

conserve resources for growth. On the other hand, firms which have rather

limited investment avenues usually pursue a more generous payout policy.

Some of the important factors that generally determine the dividend policy of a

firm are:

a. dividend payout ratio

b. stability of dividends

c. tax consideration

d. legal, contractual, internal constraints and restrictions.

e. Capital market consideration

f. Inflation, etc.

Stability of dividend is another major aspect of dividend policy. The term dividend

stability refers to the consistency or lack of variability in the stream of future

dividend. Precisely, it means that a certain minimum amount of dividend is paid

out regularly. Shares of companies are not only purchased by individuals but also

by financial institutions like ICICI, IDBI, IFCI and UTI. Such institutions and unit

trusts are some of the largest investors in corporate securities. Also companies

are always interested to have these financial institutions in the list of their

investors. Moreover, any institution would like to invest in the shares of those


companies, which have a record of paying regular dividends. As such, a

company which does not adhere to stable dividend policy would always be

disliked by these institutional investors and unit trusts, which aspires for regular

flow of income from their investment portfolio. Therefore, considering the needs

of their premiere investors, a company would always prefer to follow a stable

dividend policy.

Capital market consideration is important because if the firm has an access to

capital market for fund raising, it may follow a policy of declaring liberal dividend.

However, if the firm has only limited access to capital market, it is likely to adopt

low dividend payout ratio. Such firms are likely to rely more heavily on retained

earnings.

Inflation is also one of the factors to be reckoned with at the time of formulating

the dividend policy. With rising prices, accumulated depreciation may be

inadequate to replace obsolete requirement. These firms have to rely upon

retained earnings as a source of funds to make up the deficiency. This

consideration becomes all the more important if the assets are to be replaced in

the near future. Consequently, the dividend payout ratio tends to be low during

the period of inflation.

How Do Firms View Dividend Policy

In a classic study, Lintner surveyed a number of managers in the 1950's and

asked how they set their dividend policy. Most of the respondents said that there

were a target proportion of earnings that determined their policy. One firm's

policy might be to pay out 40% of earnings as dividends whereas another

company might have a target of 50%. This would suggest that dividends change

with earnings. Empirically, dividends are slow to adjust to changes in earnings.

Lintner suggested an empirical model whereby changes in dividends are linked

to the level of the earnings, the target payout and the adjustment rate. He asserts


that more "conservative" companies would be slower to adjust to the target

payout if earnings increased. The following, from Brealey and Myers, details his

research.

Suppose that a firm always stuck to a target payout ratio. Then the dividend

payment in the coming year (DIV_1) would equal a constant proportion of

earnings per share (EPS_1).

DIV_1 = target dividend

= target ratio x EPS_1

The dividend change would equal

DIV_1 - DIV_0 = target change

= target ratio x EPS_1 - DIV_0

A firm that always stuck to its payout ratio would have to change its dividend

whenever earnings changed. But the managers in Lintner's survey were reluctant

to do this. They believed that shareholders prefer a steady progression in

dividends. Therefore, even if circumstances appeared to warrant a large increase

in their company's dividend, they would move only partway toward their target

payment. Their dividend changes therefore seemed to conform to the following

model:

DIV_1 - DIV_0 = adjustment rate x target change

= adjustment rate x (target ratio x EPS_1 - DIV_0)

The more conservative the company, the more slowly it would move toward its

target and, therefore, the lower would be its adjustment rate.


Direction of Proportion of

earnings changes Companies

Current Previous 2-Years Increasing Maintaining Reducing

Year Year Year Dividend % Dividend % Dividend %

+ + + 81 8 11

+ + - 67 15 18

+ - + 58 17 25

- + + 54 15 32

+ - - 49 18 34

- + - 45 19 36

- - + 35 17 48

- - - 25 25 50

Summary of Factors That Could Affect Dividend Policy

Given that the firm's investment policy is fixed, MM shows that the dividend policy

is irrelevant. However, if capital market imperfections (e.g., taxes) are important

or if dividend announcements signal new information, dividend policy will be

relevant. In fact, there are important factors in dividend policy decision that are

against high dividend payout and factors are in favor of high dividend payout and

those that may affect dividend payout either way. A list of them is:

Factors Against High Dividend Payout


Personal Taxes. (Dividends are taxed, but capital gains are deferred; The latter

tax rate used to be lower; Since Tax Reform Act of 1986, equal treatment.)

Transaction Costs (From reinvesting and firm's financing.)

Factors Favoring High Dividend Payout Tax Reasons (80% dividend exclusion rule; institutional investors)

Legal and Institutional Reasons (e.g. `Prudent man' rule)

Desire for Current Income

Other Factors

The Clientele Effect

Information Content of Dividends

Other than paying dividends, a company has alternatives

Select Additional Capital Budgeting Projects

Share Repurchase

Acquire Other Companies

Purchase Financial Assets

Explanation of Factors

Personal Taxes

Before the Tax Reform Act of 1986, dividends and capital gains were

taxed at different rates. Under the old laws, dividends were taxed as ordinary

income (tax rate T_d of 50%) but you were only taxed on 40% of the capital

gains (T_cg tax rate of 20%).


Under the old system, it seemed like individuals should prefer capital

gains because T_cg < T_d. Second, you are not taxed on the capital gain until it

is realized. So you can defer your taxation.

Under the Tax Reform Act of 1986 dividends and capital gains are treated

symmetrically. Beginning in the 1988 tax year, the rate of taxation on both

dividends and capital gains is a maximum of 28%. With the new legislation, it is

more difficult to make the argument that corporations should not pay dividends

because investors prefer capital gains.

One should also note that there are many large institutional investors that

are tax exempt -- like pension funds. For these institutions, it is not even possible

to tell a story about tax deferral. The institutions should be indifferent between a

high dividend paying stock and a low dividend paying stock.

The only way to determine whether there is a tax effect makes dividend

policy relevant is to empirically examine the data to see which group dominates

the data. For example, Black and Scholes (1974) formed portfolios of stocks

based on dividend payout ratios. Each of these portfolios was adjusted for risk

with the Capital Asset Pricing Model. Black and Scholes wanted to see if there

was any significant difference in total rates of return across portfolios that were

related to dividend policy. There results showed that there was no significant

difference. This implies that the market does not reward any particular dividend

policy.

The bottom line on the tax issue depends on who the marginal investor is

in the market. If the marginal investor is large tax exempt institutions (which is

likely to be the case), then they will eliminate any tax effect. If one stock is

somehow rewarded for a particular dividend policy, the pension funds will buy in

and drive the price up until that particular firm is no different from any other firm

in the same risk class.


Transaction Costs

First, the investor must incur the transactions costs of reinvesting the

dividend income. Second, the firm may have to pay for floatation costs (if

dividend is financed by new equity) or some fees for borrowing.

Tax Reasons

The main item here is the fact that large pools of investors are institutions

which are tax-exempt.

The Clientele Effect

There are groups of individuals with different preferences for how they get

the cash flows from the firm. Some shareholders may prefer stocks that do not

pay dividends. Other shareholders may prefer stocks that pay a regular dividend.

Although we have seen how people can construct their own dividend policy,

there are some that "prefer" -- for whatever reason -- a certain type of dividend

policy.

Investors will form their well-diversified portfolios of stocks to have the

desired dividend policy. In equilibrium, no firm can affect its value by changing its

dividend policy. If a firm did change the policy, it would be dropped by one

clientele and picked up by another. Clearly, one clientele is as good as another.

All clienteles would prefer not to be constantly rebalancing their portfolios as firm

switch policies. Rebalancing is expensive due to transactions costs. Hence, all

investors’ transactions costs are minimized if the firm maintains a stable dividend

policy.

Information Content of Dividends

There may be information content to dividends. The dividend may be a

signal to the public of the management's anticipations for future policy of the firm

and prospects. If there is new good information, then managers may signal this


information to the public by raising dividends. There is reluctance to lower

dividends because managers want the dividends to represent expectations of the

future value of the firm.

An obvious question is why don't the managers inform the public about

new prospects by press releases or other non-dividend related methods? In fact,

the managers do make use of the press to announce new prospects. The

problem is credibility. Why should the public believe them? Furthermore, there is

an obvious bias because it is unlikely that they will phone a reporter to tell them

bad news. The dividend is a more credible means of conveying information

because it is costly to the firm. The more costly the signal the more believable it

is.

Dividend Reinvestment Plan (DRIP)

A DRIP (Dividend Reinvestment Plan) is a plan that enables a stockholder

to automatically reinvest dividends received back into the stock of the paying

firm. The plan may either involve the firm repurchasing existing shares or it may

involve newly issued shares.

PRACTICAL ASPECTS OF DIVIDEND POLICYWhile deciding on the dividend policy, firms face two questions:

1. What should be the average pay ratio?

2. How stable should the dividends be over time?

Firms consider the following factors to determine the payout ratio –

1. Funds requirement – The dividend pay out ratio of firms depends on the

firm’s future requirements for funds. Long term financial forecasting of


funds can assess this requirement. Usually firms, which have plans for

substantial financial investment, need funds to exploit the available

opportunities. Thus, they keep their dividend payout ratio low. On the

other hand, firms, which have very few investment avenues have larger

dividend pay out ratio.

2. Liquidity – It is another factor which influences the dividend payout ratio

as dividends involved cash payment. Firms, which desire to pay dividends,

may not do so, because of insufficient liquidity. This usually happens in

the case of profitable and expanding firms, which have very low liquidity

because of substantial investments.

3. Availability of external sources of financing – Firms which have easy

access to external sources of funds enjoy a great deal of flexibility in

deciding the dividend payout ratio. For such firms, dividend payout

decision is somewhat independent of its investment decision as well as its

liquidity position. Such firms are usually more generous in their dividend

policies. While on the other hand, firms, which do not have easy access to

external sources of funds, have to rely on the internal sources of funds or

investment purposes. Such firms are usually very conservative in their

dividend policy decisions.

4. Shareholder preference – Preferences of shareholder are another major

factor, which influence dividend payout. If shareholders prefer current

income to capital gains, then the firm may follow the liberal dividend

policy. While on the other hand if they prefer capital gain to dividend

income, then firms follow the conservative dividend policy.

5. Difference in the cost of external equity and retained earnings – The

cost of equity in all cases except for those raised by way of rights issue is

higher than the cost of retained earnings. Depending on the extent of this


difference in cost, firms decide the relative proportion of external equity

and retained earnings to be used. This affects the dividend policy decision

of the company.

6. Control – Raising money from external resources may lead to dilution of

control, in case money is raised by issuing public equity. Internal financing

on the other hand does not lead to any dilution of control. Hence, if

management and shareholders are averse to dilution of control, then firms

prefer to rely more on retained earnings. Thus, such companies may

adopt the conservative dividend policy.

7. Taxes – In India dividend income for the individuals is free, however

capital gains are taxable. Thus, in that case shareholders who are in high

tax bracket may prefer dividend income rather than capital gains.

However, if tax on dividends is viewed from point of view of corporate,

they have to pay dividend tax. Thus, this may influence the companies’

dividend policy.

Dividend-Paying Methods

Now, should the company decide to follow either the high or low dividend

method, it would use one of three main approaches: residual, stability, or a

compromise between the two.

Residual

Companies using the residual dividend policy choose to rely on internally

generated equity to finance any new projects. As a result, dividend payments can

come out of the residual or leftover equity only after all project capital

requirements are met. These company's usually attempt to maintain balance in

their debt/equity ratios before making any dividend distributions, which


demonstrates that such a company decides upon dividends only if there is

enough money leftover after all operating and expansion expenses are met.

Stability

The fluctuation of dividends created by the residual policy significantly contrasts

the certainty of the dividend stability policy. With the stability policy, companies

may choose a cyclical policy that sets dividends at a fixed fraction of quarterly

earnings, or they may choose a stable policy whereby quarterly dividends are set

at a fraction of yearly earnings. In either case, the aim of the dividend stability

policy is to reduce uncertainty for investors and to provide them with income.

Hybrid

The final approach is a combination between the residual and stable dividend

policy. Using this approach, companies tend to view the debt/equity ratio as a

long-term rather than a short-term goal. In today's markets, this approach is

commonly used by companies that pay dividends. As these companies will

generally experience business cycle fluctuations, they will generally have one set

dividend, which is set as a relatively small portion of yearly income and can be

easily maintained. On top of this set dividend, these companies will offer another

extra dividend paid only when income exceeds general obtained levels.

IMPACT OF DIVIDENDS

ARGUMENTS AGAINST DIVIDENDS

First, some financial analysts feel that the consideration of a dividend policy is

irrelevant because investors have the ability to create "homemade" dividends.

http://www.investopedia.com/terms/d/dividendpolicy.asp


These analysts claim that this income is achieved by individuals adjusting their

personal portfolio to reflect their own preferences.

The second argument claims that little to no dividend payout is more favorable

for investors. Supporters of this policy point out that taxation on a dividend is

higher than on capital gain. The argument against dividends is based on the

belief that a firm who reinvests funds (rather than pays it out as a dividend) will

increase the value of the firm as a whole and consequently increase the market

value of the stock. According to the proponents of the no-dividend policy, a

company's alternatives to paying out excess cash as dividends are the following:

undertaking more projects, repurchasing the company's own shares, acquiring

new companies and profitable assets, and reinvesting in financial assets.

ARGUMENTS FOR DIVIDENDS

In opposition to these two arguments is the idea that a high dividend payout is

more important for investors because dividends provide certainty about the

company's financial well being; dividends are also attractive for investors looking

to secure current income. Also, there are many examples of how the decrease

and increase of a dividend distribution can affect the price of a security.

Companies that have a long-standing history of stable dividend payouts would be

negatively affected by lowering or omitting dividend distributions; these

companies would be positively affected by increasing dividend payouts or making

additional payouts of the same dividends. Furthermore, companies without a

dividend history are generally viewed favorably when they declare new

dividends.

IDEAL TIME TO PAY DIVIDEND

http://www.investopedia.com/terms/c/capitalgain.asp


In the days of falling stock prices, Board of Directors will often begin to pay

dividends to help stabilize the company’s stock. Many investors consider these

dividends as a sign of safety and financial conservatism (which they are in many

cases). Dividends in and of themselves, however, do not necessarily make the

company a better investment. Companies that earn high returns on equity, have

little or no debt, and large room to expand in their current industry would best

serve their shareholders by paying no dividends. Instead, they should opt to

reinvest all of the company’s available resources into growing the value of the

underlying business.

The shareholders will be rewarded through appreciation in the stock price. In

other words, a company should only pay dividends if it is unable to reinvest its

cash at a higher rate than the shareholders (owners) of the business would be

able to if the money was in their hands. If company ABC is earning 25% on

equity with no debt, management should retain all of the earnings because the

average investor probably won't find another company or investment that is

yielding that kind of return.

The factors that may be considered by the Board before making any

recommendations for the dividend include, but are not limited to, future

expansion plans and capital requirements, profits earned during the financial

year, cost of raising funds from alternate sources, cash flow position and

applicable taxes including tax on dividend as well as exemptions under tax laws

available to various categories of investors from time to time, and money market

conditions, subject to the Government guidelines described below:

As per the guideline dated February 11, 1998 from the Government of India, all

profit-making PSUs which are essentially commercial enterprises should declare

the higher of a minimum dividend of 20 percent on equity or a minimum dividend

payout of 20 percent of post-tax profit. The minimum dividend pay-out in respect

of enterprises in the oil, petroleum, chemical and other infrastructure sectors

should be 30 percent of post-tax profits.

http://beginnersinvest.about.com/cs/financialratio/g/debttoequity.htm

http://beginnersinvest.about.com/cs/investinglessons/l/blreturnequity.htm

http://beginnersinvest.about.com/od/dividendsdrips1/a/aa040904.htm

http://beginnersinvest.about.com/cs/a/aa2203a.htm


Dilemma: Should the firm use retained earnings for:

a) Financing profitable capital investments?

b) Paying dividends to stockholders?

Stock Returns

Return =P1 - Po + D1 Po=P1 - Po + D1 Po Po= P1-P0 P0 Capital Gain

= D1 P0 Dividend Yield

Return =P1 - Po + D1 Po Po

If we retain earnings for profitable investments,



If we retain earnings for profitable investments, dividend yield will be

zero,

Return = P1 - Po + D1 Po Po

If we retain earnings for profitable investments, dividend yield will be

zero, but the stock price will increase, resulting in a higher capital gain.


If we pay dividends,


If we pay dividends, stockholders receive an immediate cash reward

for investing,


If we pay dividends, stockholders receive an immediate cash reward

for investing, but the capital gain will decrease, since this cash is not

invested in the firm.


Conclusion:

So, dividend policy really involves 2 decisions

How much of the firm’s earnings should be distributed to shareholders

as dividends, and

How much should be retained for capital investment.

Is Dividend Policy Important?

Three viewpoints:

1) Dividends are Irrelevant. If we assume perfect markets (no taxes, no

transactions costs, etc.) dividends do not matter. If we pay a dividend,

shareholders’ dividend yield rises, but capital gains decrease.

Po = D1 Kc-g

Po = D1 Kc-g

In perfect markets, an increase in dividends


Po = D1 Kc-g

In perfect markets, an increase in dividends means less money will be

invested, so the growth rate declines.

The increase in D1 is offset by the decrease in g.

Consequently, dividend policy does not affect stock price.


Dividend irrelevance: In perfect markets, investors do not care if

returns come in the form of dividend yields or capital gains.



2) High Dividends are best

Some investors may prefer a certain dividend now over a risky

expected capital gain in the future.

3) Low Dividends are Best

Dividends are taxed immediately. Capital gains are not taxed until the

stock is sold.


Therefore, taxes on capital gains can be deferred indefinitely.

Do Dividends Matter?

Other Considerations:

1) Residual Dividend Theory:

The firm pays a dividend only if it has retained earnings left after

financing all profitable investment opportunities.

This would maximize capital gains for stockholders and minimize

flotation costs of issuing new common stock.

2) Clientele Effects:

Different investor clienteles prefer different dividend payout levels.

Some firms, such as utilities, pay out over 70% of their earnings as

dividends. These attract a clientele that prefers high dividends.

Growth-oriented firms which pay low (or no) dividends attract a

clientele that prefers price appreciation to dividends.

3) Information Effects:

Raising a firm’s dividend usually causes the stock price to rise and

decreasing the dividend causes the stock price to fall.


Dividend changes convey information to the market concerning the

firm’s future prospects.

4) Agency Costs:

Paying dividends may reduce agency costs between managers and

shareholders.

Paying dividends reduces retained earnings and forces the firm to

raise external equity financing.

Raising external equity subjects the firm to scrutiny of regulators (SEC)

and investors and therefore helps monitor the performance of

managers.

5) Expectations Theory:

Investors form expectations concerning the amount of a firm’s

upcoming dividend.

Expectations are based on past dividends, expected earnings,

investment and financing decisions, the economy, etc.

The stock price will likely react if the actual dividend is different from

the expected dividend.


Stock Dividends and Stock Splits

Stock dividend: payment of additional shares of stock to common stockholders.

Example: A company announced a 5% stock dividend to all shareholders of

record. For each 100 shares held, shareholders received another 5 shares.

Did the shareholders’ wealth increase?

Stock Split: the firm increases the number of shares outstanding and reduces

the price of each share.

Example: Joule, Inc. announced a 3-for-2 stock split. For each 100 shares held,

shareholders received another 50 shares.

Does this increase shareholder wealth?

Are a stock dividend and a stock split the same?

Stock Splits and Stock Dividends are economically the same: the

number of shares outstanding increases and the price of each share drops. The

value of the firm does not change.

Example: A 3-for-2 stock split is the same as a 50% stock dividend. For each

100 shares held, shareholders receive another 50 shares.

Effects on Shareholder Wealth: these will cut the company “pie” into

more pieces but will not create wealth. A 100% stock dividend (or a 2-for-1 stock


split) gives shareholders 2 half-sized pieces for each full-sized piece they

previously owned.

For example, this would double the number of shares, but would cause a $60

stock price to fall to $30.

Why bother?

Proponents argue that these are used to reduce high stock prices to a

“more popular” trading range (generally $15 to $70 per share).

Opponents argue that most stocks are purchased by institutional

investors who have $millions to invest and are indifferent to price

levels. Plus, stock splits and stock dividends are expensive!

Stock Repurchases

Stock Repurchases may be a good substitute for cash dividends.

If the firm has excess cash, why not buy back common stock?

Repurchases drive up the stock price, producing capital gains for

shareholders.

Repurchases increase leverage, and can be used to move toward the

optimal capital structure.

Repurchases signal positive information to the market - which

increases stock price.


Repurchases may be used to avoid a hostile takeover.

Example: T. Boone Pickens attempted raids on Phillips Petroleum and Unocal in

1985. Both were unsuccessful because the target firms undertook stock

repurchases.

Methods: Buy shares in the open market through a broker.

Buy a large block by negotiating the purchase with a large block

holder, usually an institution. (targeted stock repurchase)

Tender offer: offer to pay a specific price to all current stockholders.

The balanced viewpoint

If a company has excess cash, and few good projects (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 projects

(NPV>0), returning money to stockholders (dividends or stock repurchases) is

BAD.

DIVIDEND POLICY AND SHARE VALUE

The dividend policy of a company determines what proportion of earnings is

distributed to the shareholders by way of dividends, and what proportion is

ploughed back for reinvestment purposes. Since the main objective of financial

management is to maximize the market value of equity shares, one key area of


study is the relationship between the dividend policy and market price of equity

shares.

There are four models available to show the above relationship, these are

briefly described as follows:

TRADITIONAL MODEL:

According to this model founded by Graham and Dodd, the market price of the

shares will increase when a company declares a dividend rather than when it

does not. Quantitatively P=m (D+E/3)

Where:

P is the market price per share

M is a multiplier

D is the dividend per share

E is the earning per share

WALTER MODEL:

According to this model founded by James Walter, the dividend policy of a

company has an impact on the share valuation.

Quantitatively P= (D+ (E-D) r/k)/k

Where:


P, D, E has the same connotations as above and r is the internal rate of return on

the investments and k is the cost of capital.

The impact of dividend payment on the share price is studied by comparing the

rate of return with the cost of capital.

When r>k, the price per share increases as the payout ratio decreases

(optimal payout ratio is nil)

When r=k, the price per share does not vary with the changes in the

payout ratio (optimal payout ratio does not exist)

When r<k, the price per share increases as the payout ratio increases

(optimal payout ratio is 100%)

GORDON MODEL:

According to this model founded by Myron Gordon, the dividend policy of the

company has an impact on share valuation.

Quantitatively P= Y (1-b)/ (k-br)

Where P is the price per share

Y is the earnings per share

b is the retention ratio

1-b is the payout ratio

br is the growth rate

r is the return on investment

k is the rate of return required by shareholders


On comparing r and k, the relationship between market price and the payout ratio

is exactly the same as compared to the Walter model.

MM MODEL:

According to this model, as founded by Miller and Modigliani, the market price of

the share does not depend on the dividend payout, i.e. the dividend policy is

irrelevant. This model explains the irrelevance of the dividend policy in the

following manner: When profits are used to declare dividends, the market price

increases. But at the same time there is a fall in the reserves for reinvestment.

Hence for expansion, the company raises additional capital by issuing new

shares. Increase in the overall number of shares, will lead to a fall in the market

price per share. Hence the shareholders would be indifferent towards the

dividend policy.


Chapter 2


Indian Steel Industry – An Overview

8th largest steel producer in the world

Production of Finished steel in 2005-06, 42.7 mT, a growth of 11%.

Apparent Consumption of Finished Steel in 2005-06 - 38.1mT, growth of

10.8%. Apparent consumption of Longs -16.2 mT, Flats - 21.8 mT.

Largest producer of Sponge Iron - 12.8 mT in 2005-06 (a growth of 25%).

India’s exports of Finished Steel in 2005-06, 4.4 mT, Imports 3.7 mT

Huge Iron Ore reserves – 23 bn. tonnes

Private Steel Producers are opting for Forward as well as Backward

Integration

Indian Steel Producers are increasingly looking for overseas acquisitions

in steel as well as raw materials.

INDIA’S CRUDE STEEL PRODUCTION (MT)HISTORIC TRENDS

1.25 mT in 1948in 1948

in 1948 1948

16.2 mT in 1991

41.3 mT in 2005

6.6mT in 1973in 1948

in 1948 1948

MODEST GROWTH HIGH GROWTH

India gains independencein 1947


Indian Steel Industry* Year indicates FY

* Year indicates FY

Apparent Finished Steel Consumption (mT)

Indian Steel Industry – An OverviewMajor Players

Finished Steel Production 2005-06

Company 05-06(MT)

SAIL 9.15

Enabled by India’sEconomic liberalization

SLOW GROWTH

CAGR – 7.0%


Tata Steel 3.8RINL 3.0

ESSAR 3.3ISPAT 2.6JSWL 3.5

OTHERS 17.2Total 42.7

Source - JPC

Indian Steel Industry

SWOT Analysis


SWOT ANALYSIS OF INDIAN STEELINDUSTRY

STRENGTHS

• Abundant resources of iron ore

• Low cost and efficient labour force

• Strong managerial capability

• Strongly globalised industry and emerging global competitiveness


• Modern new plants & modernized old plants

• Strong DRI production base

• Regionally dispersed merchant rolling mills

WEAKNESSES

• High cost of energy

• Higher duties and taxes

• Infrastructure

• Quality of coking coal

• Labour laws

• Dependence on imports for steel manufacturing equipments & technology

• Slow statutory clearances for development of mines

OPPORTUNITIES

• Huge Infrastructure demand

• Rapid urbanisation

• Increasing demand for consumer durables

• Untapped rural demand

• Increasing interest of foreign steel producers in India

THREATS


• Slow growth in infrastructure development

• Market fluctuations and China’s export possibilities

• Global economic slow down

National Steel Policy

Addressing the Weaknesses &

Harnessing the Opportunities

OBJECTIVE

To have modern and efficient steel industry of world standards,

catering to diversified steel demand.


To achieve global competitiveness in cost, quality, product-mix,

efficiency and productivity

To attain Finished Steel production of 110 mT pa by 2019-20

Production Imports Exports Consumption2019-20 110 6 26 90

CAGR(Base – 04-05)

7.3% 7.1% 13.3% 6.9%

STRATEGY

Demand Side – Strengthening of delivery chain

– Interface between producers, designers of steel intensive products,

fabricators and ultimate user

– Creating awareness about cost-effective and technically efficient

end-use of steel

Supply side

– Enhanced and easy access to critical inputs – iron ore & coking

coal

– Expansion and improvement in quality of infrastructure

– Well developed financial market

– Increased focus on R&D, training of manpower and integrated

information services


Strategies For Fuelling Demand

• Facilitate Rural Consumption

• Increased usage in Bridges, Crash Barriers, Flyovers and Building

Constructions

• Closer interaction between INSDAG / Large Producers and Architects/

Engineers/ Students

SAIL’S GROWTH PLANS

mT

2005-06 2011-12

Hot Metal 14.60 22.5

Crude Steel 13.47 21.6

Saleable Steel 12.05 20

-Planned Investments of US$ 7.7 bn.- Includes only growth in existing Units

Huge potential upside in Per Capita Consumption


FUTURE OF INDIAN STEEL INDUSTRY


Projected per Capita consumption of Finished Steel in India (kg)

Year Per Capita Steel Consumption

2011-12 48

2019-20 80

2024-25 110

2029-30 135

2034-35 175


India’s current population is - 1050 millionIt is assumed that till 2051, population would be about : 1.4 bn.

GROWTH SCENARIOS

Optimistic Case Medium Growth

Conservative

Fin. Steel Cons.Growth Rate

Consum-ption(mTpa)

Fin. Steel Cons. Growth Rate

Consum-ption (mTpa)

Fin. Steel Cons. GrowthRate

Consum-ption (mTpa)

2005-2020

7.6% 100 6.9% 90 * 5.5% 76

2020-2030

6.5% 188 5.5% 147 4.5% 118

2030-2040

5.0% 305 4.0% 217 3% 158

2040-2050

5.0% 498 4.0% 322 3% 212

* - Also projected by National Steel Policy

INDIAN STEEL INDUSTRY A BRIGHT FUTURE

RESOURCES

Abundant Iron Ore reserves

Strong Managerial skills in Iron and Steel making

Large pool of skilled Man-power

Established steel players with strong skills in steel making


OPPORTUNITIES

High economic growth driven increasingly by industry

Faster Urbanisation

Increased Fixed Asset Building

Automobiles and component industry growth

POLICY

Pro-active stance of Govt.

Encouragement for overseas investments


Chapter 3

WHAT WE INTEND TO EXPLORE?

The impact of dividend on the share prices.

Intra and Inter sectorial analysis.

HOW WE INTEND TO EXPLORE:

0

10

20

30

40

50

60

70

80

1 2 3 4 5 6

Series1


NOTE: The dashed line shows the ex-dividend date. The line at the left indicates

a span of 15 days prior to the ex-dividend date. The line at the right indicates a

span of 15 days post the ex- dividend date.

For establishing the impact of dividend on market share price, we chose. the

steel sector. The sector was deliberately chosen to bring in diversity in our

analysis. The steel sector is a capital intensive industry which historically had

been paying less dividend.

The price fluctuation around the ex-dividend date is considered for our study.

Prior to the ex-dividend date, the market reacts to the dividend declared. The

same is true for the market price fluctuation after the ex-dividend date.

We found out the market share price for various companies under the mentioned

sectors. The difference between the market share price on the ex-dividend date

and 15 days prior to date gives us the fluctuation in anticipation of the ex-

dividend. Similarly, the difference between the ex-dividend and the market share

price on 15 days later to the ex-dividend gives us the fluctuation as the market’s

reaction to ex-dividend. We ran a regression to establish the coefficient of

correlation between the anticipatory fluctuation and the DPS (dividend per share)

and also between the post fluctuation and DPS. That apart a separate correlation

is run between DPS and PAT to establish whether companies declares dividend

based on their net earnings.

SECTORS CHOSEN


STEEL

SAIL

TATA STEEL

JINDAL

ASSUMPTIONS:

1) Dividend the main reason behind the market price fluctuation pre and post

the ex-dividend date.

It is important to note here that market price fluctuates based on various

quantitative and/or qualitative factors. It also depends on the speculation

or future earnings. Dividend is just one factor that may (yet to be

established in our project) affect the market share price. Yet it is important


to assume that other factors here do not play a very important role in

affecting the market share price. This assumption is possible because we

took a very small time span of 15 days either way.

2) Dividend is paid from PAT.

It can be assumed that dividend is paid by the net earnings after tax and

retaining some reserves for future investment which is decided by the

company management and approved by the board of directors. But this is

not always the case. For instance, we find several instances where

company paid dividend even though it had a negative earnings i.e. it made

loss. This is done by shelling out money from the reserves or surplus so

that the market sentiment of the investors does not turn sour. In our

analysis we assumed that whatever PAT is paid, it is through the net

earnings that year.


Chapter 4

Data for SAIL - ALL from 25-7-2006 to

25-8-2006

Series DatePrev Close Open High Low Close

Total Trd Qty Turnover

in LacsEQ 25-Jul-06 66.1 67 68.65 67 68.3 4653198 3,167.31EQ 26-Jul-06 68.3 69 70 67.4 68.9 5414926 3,745.16EQ 27-Jul-06 68.9 69.2 70.8 69 69.55 6952882 4,857.13EQ 28-Jul-06 69.55 69.9 72.95 69.7 71.45 15210235 10,905.11EQ 31-Jul-06 71.45 72.75 72.75 69.5 70.25 5254045 3,759.79EQ 1-Aug-06 70.25 70.25 71.2 68.4 69.1 5215522 3,617.84EQ 2-Aug-06 69.1 69.5 70.85 68.65 70.6 4620631 3,238.38EQ 3-Aug-06 70.6 70.9 72 70.9 71.45 5203447 3,725.76


EQ 4-Aug-06 71.45 71.75 73.25 71.25 71.9 8310806 6,007.06EQ 7-Aug-06 71.9 71.9 72.2 69.8 70.15 5366206 3,787.01EQ 8-Aug-06 70.15 70.15 74.6 70 73.85 8542699 6,197.21EQ 9-Aug-06 73.85 73.8 76.8 72.6 76.1 10249346 7,705.15EQ (ex div)10-Aug-06 76.1 75.8 76.5 75 76.2 5821528 4,424.68

EQ(ex div 10 Aug)8/11/2006 76.2 76.5 78.15 75.4 77.45 8165821 6,264.04

EQ 14-Aug-06 77.45 78 79.4 77.1 77.65 6012906 4,706.28EQ 16-Aug-06 77.65 78.5 79.6 77.25 77.9 5053461 3,971.25EQ 17-Aug-06 77.9 78 78.65 74.8 76.15 6953959 5,287.94EQ 18-Aug-06 76.15 75.85 77.25 74 76.9 4633969 3,524.01EQ 21-Aug-06 76.9 77.5 77.5 75.45 75.65 2927378 2,220.63EQ 22-Aug-06 75.65 76 78.65 75.9 77.65 7770429 6,039.48EQ 23-Aug-06 77.65 77 78 75.85 76 3513981 2,692.31EQ 24-Aug-06 76 76 76.15 72 75.65 5209821 3,927.13EQ 25-Aug-06 75.65 73.5 77.35 73.5 76.7 4861452 3,730.16

Close

62646668707274767880

pric

e

Close

Data for TATASTEEL - ALL from 11-5-2006 to 11-6-2006



in LacsEQ 11-May-06 668.1 675 675.4 634.2 639.05 4585216 29,950.33EQ 12-May-06 639.05 639.9 658 625.4 643.85 4940660 31,962.60EQ 15-May-06 643.85 644 647 572.35 586.65 9410320 57,635.63IL 15-May-06 621.5 640 640 640 640 200000 1,280.00EQ 16-May-06 586.65 583.8 592 525.5 574.25 10314199 57,401.51EQ 17-May-06 574.25 590 618.5 583 611.9 6914729 41,944.49EQ 18-May-06 611.9 610 610 530.2 545.05 9533768 54,050.94EQ 19-May-06 545.05 570 570 495 504.3 8717406 45,635.12


EQ 22-May-06 504.3 510 512 430 470.9 4973313 23,768.19IL 22-May-06 640 520 520 520 520 2700000 14,040.00EQ 23-May-06 470.9 472 514 443 510.75 4334583 21,167.09EQ 24-May-06 510.75 519.9 527 476.5 483.9 4470864 22,663.56EQ 25-May-06 483.9 478.7 524.7 464 515.85 5945449 29,668.60

EQ ex div 26 may 515.85 516 557 510 538.95 7846832 42,485.89

EQ 29-May-06 538.95 545 570 539 562.15 5909784 32,646.45EQ 30-May-06 562.15 568.8 568.8 540 547 4133593 23,036.65EQ 31-May-06 547 538 538 492.65 517.2 6600982 33,808.86EQ 1-Jun-06 517.2 530 532.4 480.25 488.95 5589420 28,637.81EQ 2-Jun-06 488.95 490 522 481 517.8 5559379 27,906.71EQ 5-Jun-06 517.8 531.1 540 490.4 494.4 4586344 23,509.39EQ 6-Jun-06 494.4 480.05 501.5 472.3 480.35 5302756 25,801.79EQ 7-Jun-06 480.35 473.15 487.45 450 460.9 5643300 26,416.08EQ 8-Jun-06 460.9 460 460 418.1 424.9 5185540 22,679.97EQ 9-Jun-06 424.9 425 460.9 421 456.05 4405620 19,779.62

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Data for JINDALSTEEL - ALL from 31-8-2006 to 29-9-2006



in LacsEQ 31-Aug-06 1,508.45 1,523.00 1,525.00 1,478.00 1,482.05 102134 1,530.62EQ 1-Sep-06 1,482.05 1,480.10 1,506.95 1,480.10 1,500.70 25942 389.2EQ 4-Sep-06 1,500.70 1,522.95 1,522.95 1,500.00 1,508.25 4010 60.63EQ 5-Sep-06 1,508.25 1,501.00 1,534.50 1,501.00 1,529.90 18166 277.37EQ 6-Sep-06 1,529.90 1,565.00 1,599.75 1,535.00 1,584.80 36705 576.2EQ 7-Sep-06 1,584.80 1,575.55 1,649.80 1,550.10 1,640.25 60725 989.72EQ 8-Sep-06 1,640.25 1,640.25 1,665.00 1,605.00 1,623.20 31186 509.49EQ 11-Sep-06 1,623.20 1,621.50 1,633.00 1,500.00 1,530.25 46523 738.27


EQ 12-Sep-06 1,530.25 1,570.00 1,570.00 1,480.00 1,549.75 48930 751.68EQ 13-Sep-06 1,549.75 1,590.00 1,630.00 1,560.10 1,612.70 57992 931.14EQ ex div 14 sep 1,612.70 1,620.00 1,651.00 1,585.25 1,643.10 42715 697.46

EQ(ex div 14 sept)9/15/2006 1,643.10 1,612.00 1,628.10 1,590.00 1,614.70 16653 268.69

EQ 18-Sep-06 1,614.70 1,600.00 1,635.00 1,600.00 1,606.30 13856 223.16EQ 19-Sep-06 1,606.30 1,497.85 1,690.00 1,497.85 1,571.90 61123 989.14EQ 20-Sep-06 1,571.90 1,555.00 1,599.80 1,530.10 1,575.25 14330 226.2EQ 21-Sep-06 1,575.25 1,560.50 1,638.00 1,560.50 1,629.85 75418 1,218.33EQ 22-Sep-06 1,629.85 1,602.00 1,682.00 1,601.00 1,661.15 52601 860.34EQ 25-Sep-06 1,661.15 1,670.00 1,686.75 1,660.00 1,665.40 27464 458.87EQ 26-Sep-06 1,665.40 1,656.10 1,684.80 1,625.20 1,664.20 27838 463.97EQ 27-Sep-06 1,664.20 1,665.00 1,699.00 1,625.00 1,628.90 48334 795.44EQ 28-Sep-06 1,628.90 1,563.55 1,693.00 1,563.55 1,640.45 68228 1,110.69EQ 29-Sep-06 1,640.45 1,651.00 1,728.50 1,651.00 1,712.00 88638 1,514.92

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These are the return which STEEL sector is getting before and after ex dividend

date.

DPSReturn(pre ex dividend)

Return(post exdividend)

SAIL 1.9432 0.15128593 0.00656168

TATA STEEL 12.62 -0.227885047 -0.153817608

Jindal Steel 14.81 0.069110677 0.041932932


Here the company Tata Steel is getting negative return of -0.2278 before ex

dividend date and -0.1538 after ex dividend date. On the other side SAIL and

Jindal Steel are getting positive return both before and after ex dividend date, but

the return of both the companies after ex dividend is lesser then what they are

getting before ex dividend date.

Overall the return pattern of different companies is fluctuating.

One thing is to be noted here. If you study the Historical price volume

data (given above) of the three companies carefully, you will find that the

market price of all the three companies is increasing on that particular ex

dividend day.

This shows that there is some positive role of dividend in affecting the market

price.


Chapter 5

SAIL

Mar-06 Mar-05 Mar-04 Equity Dividend 826.08 1,363.03 0 Preference Dividend 0 0 0 Corporate Dividend Tax 115.86 185.24 0 Equity Dividend (%) 20 33 0


Earning Per Share (Rs.) 9.44 16.06 6.08 SOURCES OF FUNDS : Share Capital 4,130.40 4,130.40 4,130.40 Reserves & Surplus 8,471.01 6,176.25 907.27

Mar-06 Mar-05 Mar-04 PAT 4,012.97 6,816.97 2,512.08 Dividend 826.08 1363.03 0 DIVIDEND PAYOUT RATIO 20.58525232 19.99466038 0 DPS 1.943247819 3.211142458 0 CORRELATION DPS & PAT 0.957134887

DPS vs. Anticipatory Fluctuation 0.369

DPS vs. Post Fluctuation 0.241

TATA STEEL

Mar-06 Mar-05 Mar-04 Equity Dividend 719.51 719.51 368.98 Preference Dividend 0 0 0 Corporate Dividend Tax 100.92 101.86 47.27 Equity Dividend (%) 130 130 100 Earning Per Share 61.51 60.91 46.02


(Rs.)

Mar-06 Mar-05 Mar-04 Profit After Tax 3,506.38 3,474.16 1,746.22 Divided 719.51 719.51 368.98 DIVIDEND PAYOUT RATIO 20.5200235 20.71032998 21.13021269 DPS 12.62186645 12.61466199 9.724123879 CORRELATION DPS & PAT 0.999904201



JINDAL STEEL

Mar-06 Mar-05 Mar-04 Equity Dividend 46.19 30.79 18.29 Preference Dividend 0 0.15 3.76 Corporate Dividend Tax 6.33 3.96 2.34 Equity Dividend (%) 300 200 125


Earning Per Share (Rs.) 165.38 97.84 95

Mar-06 Mar-05 Mar-04 Profit After Tax 515.71 305.46 145.08 Divided 46.19 30.79 18.29 DIVIDEND PAYOUT RATIO 8.956584127 10.07987953 12.60683761 DPS 14.81239883 9.862154128 11.97649573 CORRELATION DPS & PAT 0.632740073



CORRELATION BETWEEN DPS AND PAT

COMPANY DPS vs. PAT

SAIL 0.9571

TATA STEEL 0.9999

JINDAL STEEL 0.6327GRAPH DEPICTING CORRELATION BETWEEN DPS AND PAT


DPS vs PAT

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SAIL TATA STEEL JINDAL STEEL

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The degree of correlation between DPS and PAT is quite fluctuating. Yet the value is

generally high for all with the lowest being 0.6327 of Jindal Steel and highest being

0.9999 of Tata Steel. It does convey the message that companies take into consideration

the PAT before declaring the dividend.

CORRELATION BETWEEN DPS VS Anticipatory fluctuation and DPS Vs Post fluctuation

COMPANY

DPS vs. Anticipatory Fluctuation

DPS vs. Post Fluctuation

SAIL 0.369 0.241

TATA STEEL0.122 0.015

JINDAL STEEL0.004 0.002

GRAPH DEPICTING CORRELATION BETWEEN DPS AND Anticipatory fluctuation


DPS vs Anticipatory Fluctuation

00.050.1

0.150.2

0.250.3

0.350.4

SAIL TATA STEEL JINDALSTEEL

DPS vs AnticipatoryFluctuation

The degree of correlation between dividend paid and the market’s anticipatory fluctuation

is quite very low. However SAIL shows a little bit correlation of 0.369 between the DPS

(Dividend per share) and Anticipatory fluctuation i.e. pre market fluctuation. Tata Steel

and Jindal Steel show correlation of 0.122 and 0.004 which was very low. It shows that

the market had no anticipation before the ex-dividend date.

GRAPH DEPICTING CORRELATION BETWEEN DPS AND Post Fluctuation

DPS vs Post Fluctuation

0

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SAIL TATA STEEL JINDAL STEEL

DPS vs PostFluctuation


The degree of correlation between DPS and the post ex-dividend market price fluctuation

is quite low indicating that market did not respond either way, post the ex-dividend date.


Chapter 6


CONCLUSION

1. Dividend has a positive impact on the share price according as per our

finding. However, the effect is not very profound and is rather low.

2. The low degree of correlation especially when we compared the long term

market share price with the dividend indicates that there exists “other

factors” which affects the market share price. The impact of these “other

factors” increase as the time consideration increases.

3. We also found out through our study that prices rose faster in case of

those shares where dividends were declared in form of stock options

rather than cash payments.

4. Dividend is related to cash flow and not reported earnings. This was a

certain extent corroborated in our project also where we found out that the

amount of dividend paid is not in direct proportion to the profits. In certain

cases companies paid dividend even though it reported loss.

5. We also found out that in the long run the market share price rose fast for

a company which paid low dividend in the past. Excluding extraneous

circumstances we assume that the market values dividend payout less

than the capital gains it accrues due to retention and reinvestment of

surplus funds.

6. For companies having high percentage of institutional investors, market

price of stock rose faster. This can be partly explained by the fact that


unlike retail investors, institutional investors are more interested in capital

appreciation and seek lesser dividend.

Recommendation

It is a matter of fact that dividends are declared by a company primarily to

generate capital and also at certain times to maintain the market sentiment. It

is in the best interests of the company to maximize the market value of its

share and companies use dividend as a tool to maintain their corporate

image. However, the degree of correlation between the dividend and the

market price is low which implies that several other internal and external

factors affect the market value of shares.

My study over the topic ‘Impact of Dividend on Stock Prices’ shows that

dividend has a positive impact on the share price according as per our

finding. However, the effect is not very profound and is rather low. There are

other factors which also play an important role to effect market price of the

share. Dividends are declared at the annual general meeting of our

shareholders, based on recommendations of the board of directors. The

board recommends dividends at its discretion. Generally, the factors that the

board may consider before making any recommendation include (but are not

limited to) future expansion plans and capital requirements, profit earned

during the financial year, overall financial conditions, the cost of raising funds

from alternative sources, liquidity, applicable taxes (including tax on dividend)

as well as exemptions under tax laws available to various categories of

investors from time to time, and money market conditions.

Whatever the reason of different companies for issuing dividend, but the main

purpose behind it was to have a positive impact on their shares.


As far as my knowledge is concerned dividend are the right of the

shareholders and if the companies have surplus money then they must issue

dividends.

The investor would not be able to know the inner position of the company, if

the company doesn’t want to disclose it. They normally judge the position of

the company whether it is good or bad, whether it is advisable to invest in that

particular company or not, on the bases of the companies’ dividend policies.

Different companies have different dividend policies; it depends on company

which policy is good for them.

The low degree of correlation especially when we compared the long term

market share price with the dividend indicates that there exists “other factors”

which affects the market share price. The impact of these “other factors”

increase as the time consideration increases. Therefore I would like to

recommend that in above case where companies who are not in good

position to give high dividend should not go for it. It may be possible that

because of issuing dividend, these types of companies would be able to

increase the market value of their shares, but the effect of such increase in

share value will be for a short period only. In long term market will definitely

correct itself and return to its actual position. I just want to say that this effect

in market price will be for a short span of time. If you really want to take the

benefit in the long term then it’s better to look for other options.

Like in the case of the Steel Sector, there are lots of options available for this

sector. Right now this sector is on booming side. It is better for this sector to

invest its profit for further growth, which will increase its value in the future (in

long term). After such investment if still they left with enough surplus then

they can distribute it in their shareholders as the dividend.

I also found out through my study that prices rose faster in case of those

shares where dividends were declared in form of stock options rather than

cash payments. Therefore those companies who don’t have enough reserve


to pay dividend, it’s better for them to give stock dividend instead of cash

dividend.

LIMITATIONS1. We ignored the effect of other factors on market share price. Even though

a short time span of around 15 days ensures that the effect of other

factors is minimal, yet it cannot be ruled out.

2. We have considered only one sectors and three companies for our

analysis and thus generalization is not easy or recommended.

3. We have not considered extraneous factors like the impact of expansion

plans or possible strife between management and ownership in the

intervening period which would have a major impact on the share prices.

4. We have not taken into account the declaration of dividend date and this

is a very important factor that we have overlooked, due to which our

analysis may be flawed. As based on the declaration of the amount of

dividend, the price of the share may go up or low and we may not have

factored in this all important change due to be short of data and time .As a

result our true base may be flawed on which we are basing our

calculations and we may not be able to capture the true results.

5. PAT need not necessarily be paid from the net earnings. It sometime is

paid from the reserves and surpluses. This we failed to capture.


Chapter 7


Bibliography

www. moneycontrol.com

www.moneypore.com

www.indiainfoline.com

www.sail.org

www.jindalsteel.co.in

www.tatametaliks.co.in

www.investorwords.com/1509/dividend.html

www.teenanalyst.com/glossary/d/dividend.html

www.atlanticfinancial.com/dictionary/ dividend .htm

www.answers.com/topic/cumulative- dividend

www.nseindia.com

www.bseindia.com

www. google.com

www. finance . yahoo .com

Fundamenals Of Corporate Finance [Ross-Weterfield-Jordan]

Corporate Finance [Khan & Jain]

Financial Staement Analysis [I.M. Pandey]

Financing & Dividend Decisions

http://www.answers.com/topic/cumulative-dividend

http://www.atlanticfinancial.com/dictionary/dividend.htm

http://www.teenanalyst.com/glossary/d/dividend.html

http://www.investorwords.com/1509/dividend.html

http://www.tatametaliks.co.in/

http://www.jindalsteel.co.in/

http://www.sail.org/

http://www.moneypore.com/


Chapter 8


ANNEXURE

Key Financial Ratios

Steel Authority of India Ltd

Year Mar 07 Mar 06 Mar 05 Mar 04 Mar 03

Debt-Equity Ratio 0.28 0.44 0.94 2.86 5.02

Long Term Debt-Equity Ratio 0.24 0.40 0.83 2.28 3.58

Current Ratio 1.36 1.18 0.99 0.75 0.66

TURNOVER RATIOSFixed Assets 1.33 1.14 1.15 0.87 0.70

Inventory 5.99 6.17 8.80 7.10 4.95

Debtors 18.82 17.25 18.52 15.04 12.63

Interest Cover Ratio 29.37 13.20 15.36 3.75 0.67

Operating Profit Margin(%) 27.78 22.58 34.80 19.50 10.74

Profit Before Interest And Tax Margin(%) 24.71 18.89 31.28 14.85 4.79

Cash Profit Margin(%) 18.78 15.97 24.81 15.06 3.62

Adjusted Net Profit Margin(%) 15.71 12.28 21.29 10.41 -2.33

Return On Capital Employed(%) 51.28 38.03 68.77 25.36 0.00

Return On Net Worth(%) 41.47 35.04 88.85 66.43 0.00

Tata Steel Ltd




Current Ratio 1.24 0.71 0.65 0.67 0.70


Inventory 8.77 8.47 10.17 9.93 9.01

Debtors 33.74 30.57 25.74 14.81 9.64






Adjusted Net Profit Margin(%) 21.37 20.46 21.89 14.65 11.99



Jindal Steel & Power Ltd




Current Ratio 0.88 1.03 1.10 1.03 1.17


Inventory 6.44 6.97 10.78 9.32 10.51

Debtors 12.58 12.18 12.75 7.39 6.70





Adjusted Net Profit Margin(%) 18.03 19.91 21.07 21.97 18.27



impact of dividend on stock prices

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