Sample Essay on Dividend Payment Policies & Effect on the Firm &Its Share Price

Abstract

Walmart is one of the most influential, players in the global retail and distribution markets. The company bears different banners in different countries and has over eleven thousand stores operating under its banners in more than twenty five countries. The company grew from a small retail store purchased from the Butler Brothers to what it is today. The company’s focus on higher sales volume to push its profit margins up rather than rely on high profit margin per item associated with retailing at the time proved to be an ingenious policy. Although initial profits subsided as the business geared towards its new operation policy, the procurement of goods at even cheaper prices from other suppliers turned fortunes around. As it is the law with publicly owned companies, all shareholders are entitled to portions of the company’s profits in the form of dividends as a return on investment in the venture. Since its listing, the firm has conformed to financial reporting standards and requirements and paid dividends for shares held annually and continuously since 1974.

Discussion

The firm is a retail and distribution giant with one of the highest market values in the world (Laura et al, 2013). Other than valuation, the company holds numerous accolades making it one of the most attractive investment options in the globe. The company has been the biggest revenue generator in the world and boasts an expansive workforce of over two million workers across the globe (Laura et al, 2013). The company has a workforce of more than two million, making it the largest employer in the world’s private sector. Groceries and fresh produce surprisingly constitute a large share of the company’s income, most recent reports placing their contribution at 51% of the total income generated by the retailer.

Over the last three years, the company has experienced continued growth in revenue, achieving revenues of $469 billion, $446 billion, and $421 billion in the 2013, 2012, and 2011 financial years respectively. As a result, net profits have sustained growth except for a small dip experienced in the 2012 financial year.

After releasing financial results for the 2013 financial year, the board had approved a dividend payout of $13 billion, yet another increase in the cash paid out to investors. As a result, each shareholder shall receive a dividend payment of $1.88 per share held, an approximate twenty percent increase compared to the previous year. Since the payment of the company’s first dividend in 1974, it has never failed to approve a dividend payment for its shareholders. Furthermore, the value of each dividend payout per share from one year to the next has never been revised downwards.

Due to the profit retention policy practised by the firm, the yield per dividend remains relatively low compared to the market average. For the last financial year, the company’s dividend yield stands at 2.5% compared to an industry average of 2.7%. The company retains 39% of its profits and pays out the rest as dividends and stock buybacks.

The continued strengthening of the share value despite the fairly constant dividend yield can be attributed to several factors (Victor, 2010). A low dividend yield for a well performing company indicates the company’s policy of retaining profits with the aim of future investments. This is advantageous to the investor as future investments mean increased returns fuelled by two factors. One of these factors is the fact that capital gains for existing companies usually enjoy taxation advantages and as a result, earnings from these investments achieve higher profits and better dividends in return (Victor, 2010). The other point is that retained profits usually indicate better dividend payments in future as the company creates fund to cushion investors from declines in profitability or certain periods of incurring loses. Without this fund, the investors would not receive dividends if the company incurred losses or would receive smaller dividends if profitability reduced. As a result, the company’s shares continue to prove a worthwhile investment to venture into.

The company does not face competition from other companies of its operational scale since no other company operates on such levels. It faces competition from smaller departmental outlets that operate as regional chains. These outlets include Kmart in the vast North American region, and the Giant Tiger in the Canadian market (Graff, 2006). Most of these companies offer smaller dividends per share but have a higher dividend yield than Walmart. The higher yield is due to the lesser value of retained shares as per the company policy or expansion activities. Consequently the yield does not serve as a reliable indicator on the health of the business as Walmart continues to pay a better dividend and achieve better result despite the lower dividend yield. The company is expected to increase its share price to around $1.95 following the company policy and history of increasing share prices by a substantial amount, normally around twenty percent.

In 2008 the American Insurance Group went through one of the most trying times since its inception. The company had sustained major losses but the management insisted on the quarterly payment of dividends at $4 per share erasing almost two decades of accumulated profits (Yahoo, 2014). The management insisted that the dividend payments were an indicator of the board’s confidence in the long term strengths of the business. The misguided belief almost ran the firm into bankruptcy.

When the company went under receivership and the treasury department took over its affairs, the first thing they did was stop the payment of dividends. The idea of reducing dividend pay outs or stopping them altogether is not so popular in American markets (Morgan, 2014). Top level management in these firms realise that most of the stock buyers aim at receiving cash dividends rather than capital gains on shares held or stock dividends (Mohammad, 2012). As a result, they realize that negatively adjusting the dividend payouts will have unfavourable effects on the company’s share prices (Morgan, 2014). They therefore insist on the payment of higher dividends in subsequent years, regardless of the ramifications on the firm (Mohammad, 2012).

The payment of dividends irrespective of the company’s performance is not a wise move and most companies that insist on this policy end up running bankrupt due to depletion of its reserves (Victor, 2010). The depletion of these reserves means that the company’s cash flows is negatively affected, resulting in cash constrains for investment and expansion of the firm.

For a company to grow sustainable and weather tough periods such as the recession experienced globally from 2007 to 2009, it has to have a sound profit retention policy. The policy should indicate the portion of profits to be retained from every year’s operations (Victor, 2010). Furthermore, the policy is not a stand-alone measure; it should be supported by the company’s expansion plans. These plans should offer a blueprint as to the scale in which the company seeks to expand. The development of a sound long-term plan for the company means reserved profits are channeled to specific functions and the company always retains a cash reserve to cushion it from unprofitable periods (Victor, 2010). Higher profit retention policies indicate fast growth and offer an attractive investment option for capital gains stock investors (Victor, 2010).

When AIG stopped paying dividends, the stock prices went down significantly as many cash dividend investors deemed the stock unfavourable (Merkel, 2014). However, capital gains investors seized the opportunity to acquire share from the exiting investors. The non-payment of dividends ensures the firm has sufficient funds to finance expansion and acquisition without seeking external financing which is usually quite expensive (Merkel, 2014).

Proper management of the firm’s affairs have pushed share prices from $1.57 in January 2009 to $32.82 in December 2008 (Yahoo, 2014). As a result, capital investors who invested in the firm at the time have seen their investments grow exponentially due to the non-payment of dividends and reinvestment of the cash held in company reserves (Victor, 2010).

References

Graff, O. T. (2006). Unequal Competition Among Chains of Supercenters: Kmart, Target, and Wal-Mart. University of Arkansas, Arkansas.

Laura, W., Shuojun W., Jiangbo Z., & Yongheng A. (2013). Strategic Analysis for Walmart: Save Money Live Better. Simon Fraser University, Canada.

Merkel S. (2014). Lessons on Corporate Dividend Payout and Retention Ratio. Investopedia. Retrieved from <http://www.investopedia.com/articles/investing/082613/lessons-corporate-dividend-payout-and-retention-ratio.asp>

Mohammad, H. (2012). The Impact of Dividend Policy on Share Price Volatility in the Malaysian Stock Market. Journal of Business Quarterly, 4, 111-129.

Morgan, H. (2014). What American Companies Get Wrong When Paying Dividends. The Motley Fool. Retrieved from <http://www.fool.com/investing/general/2014/02/11/what-american-companies-get-wrong-when-paying-divi.aspx>

Victor J. (2010). Understanding Dividend Payout and Retention. Share Market School. Retrieved from <http://www.sharemarketschool.com/understanding-dividend-pay-out-ratio/>

Yahoo Finance. (2014). American International Group (AIG): Historical Prices. Retrieved from <http://finance.yahoo.com/q/hp?s=AIG&a=08&b=7&c=2007&d=10&e=25&f=2014&g=m&z=66&y=0>