Dividends and Dividend Policy - Essay Example

INVESTMENT DECISION ANALYSIS Wide number of factors drives investment decisions of the business. Business investment decisions are required to be aligned with the objectives set forth by the company (Salo, Keisler, and Morton, 2011). In this similar format, the report takes into account the assessment of two potential investment options including J D Wehttherspoon and Scottish & Southern Electricity plc and Energy Company and the selection of the investment decision will be made in line with fact that investment option contributes in the short term and long term objectives set forth by the Next Plc. 1.0 ASSESSMENT OF J D WEHTTHERSPOON J D Wetherspoon plc incorporated in the London Stock Exchange is a firm with the operations in the development and management of public houses. Incorporated in the year 1979, the company owns and operates 927 pubs offering food and drinks throughout the United Kingdom (Yahoo. Finance, 2014a).  1.1. ANALYSIS OF FINANCIAL STATEMENT A review of the financial condition of the firm for the past five years conducted as follows (MorningStar, 2014a): The overall performance of the Wehttherspoon remained improving for the past five years of assessment. The liquidity position of the company is notably low which further declines under the pressure of inventory; while the profitability of the company is the declining as a result of increasing level of costs such as labour cost, marketing expenses and other repair and refurbishment etc (Reuters, 2013). The star year the in the recent most history of the company remained the year 2012 where Wetherspoon notable grew its revenue and profits in the year 2012. The underlying reason for such growth has been Euro 2012 football tournament and the Diamond Jubilee in which the company opened net of 37 pubs in UK (BBC, 2012a). However, the impact of this event was clearly expected not to be sustained over a period of long term (BBC, 2012b). Despite this fact, the company is expanding its business to sustain the growth. For the purpose, expansion of the retail space of pubs is increasing, and the company has also expanded with a new pub in the Ireland (Yahoo. Finance, 2013). Expansion is widely being financed by debt in addition to the retained earnings (J D Wetherspoon Plc.,2014); hence, affecting the interest coverage ratio. Also, the gap between the EBITDA and EBIT is also increasing as the depreciation and the amortization expenses are increasing. Consistent expansion and rising cost have affected the margins within turn is reflected in the ROE OF the company in the year 2013 and onwards (BFN News,2013). For a similar reason, the EPS of the company has also declined. In the view of the capital expenditure that company has been incurring and planning to continue so in the in future dividend level will remain same, as agreed upon by the board of directors (J D Wetherspoon Plc, 2014). 1.2. ANALYSIS OF SHARE PRICE TREND According to the efficiency market hypothesis, the share price of the company is an estimate of the intrinsic value of the firm, and the estimate does not carry any bias. It is important to point here that these estimates are not always equal to the intrinsic value, instead are estimated values which may have certain level of deviations under the influence of other factors (Chandra, 2009). The above discussed growth of the company is being equally reflected in the investors’ sentiment and accordance with the efficiency market hypothesis. The company’s share price trend for the past five years has been as follows: Fig: 1 SHARE PRICE TREND OF Wetherspoon (J D) FROM 2010-2014 (MorningStar, 2014a) The above trend reflects the inflation point of the share price right after the year 2012. The working reason behind this positive sentiment of the investors is related to exceptional growth of the company sales in the year 2012. However, since then the company did not maintain the growth momentum but at an attractive level managed to grow well. For example, contrary to its new sites estimate of 30 for the year 2013, Wetherspoon expanded its expansion plan to 50 total new sites (Yahoo. Finance, 2013). Investors also remained positive about the growth of the company. Hence, it implies that the market of LSE can be defined as the strong form of efficiency market hypothesis as it has clearly reflected the changes in the variables that have influenced the performance of the firms. Strong form of efficiency market is one that completely incorporates all information relevant to the firm (Chandra, 2009). 1.3-P/E RATIO ANALYSIS The investors’ sentiment is evident from the given below P/E ratio trend that is growing with every year: 2010 2011 2012 2013 2014 P/E Ratio (X) 13.26 11.32 13.09 18.94 22.45 Earning (GPp) 30.2 35.4 33.75 36.6 32.8 Price (GBp.) 400.53 400.9 441.7 693.38 736.28 1.4- COMPARISON WITH INDUSTRY PEERS It is important to notice that company has recently managed to gain the industry momentum as the competitors, or the peers of the company already had growing share price as evident from the trend below: Figure 2: SHARE PRICE COMPARISON OF WETHERSPOON WITH PEERS (Financial Times, 2014a) One potential reason for this growth is the share price is the nature of the industry. Wetherspoon belongs to the restaurants industry which is cyclical in the nature. As s result the company has a beta of 0.7051 (Financial Times, 2014a). Beta is the relative measures of the company’s movement with the market. Therefore, revival measures of the economy are also expected to have reflection on the share price of the company (Fabozzi, 2008). Hence, the overall performance of the company is positive and has long term positive future potential as the company will capitalize on the investments. Aligned with this fact is the future forecast about the company that entails around 9% growth in the revenue and 7.5% growth in the earning of the company. 2.0. SCOTTISH & SOUTHERN ELECTRICITY PLC AND ENERGY COMPANY The other investment option is Scottish and Southern Electric Plc and the Energy Company. The business of SSE plc is related to the generation, transmission, distribution, and supply of electricity in the states of UK and Ireland. In addition to this, SSE business concern also involves the production, distribution, storage supplies of natural gas to UK and Ireland. The company is also involved in the production and distribution of energy related products and services to the large number of businesses and residential clients (Morning Star, 2014b; Yahoo. Finance, 2014b). 2.1. ANALYSIS OF FINANCIAL STATEMENT The trend of the five years performance of SSE is presented below (MorningStar, 2014b): SSE belonging to public sector is faced with the challenge of meeting the consumer demand while maintaining its prices. Overall there has been a consistent trend in the performance of the SSE except 2013 where the company reported decline in the revenue as a result of the cut in the consumer spending for energy. The liquidity of the company is on the edge and has the potential of improvement for sound position. As a matter of fact under the impact of rising cost, government regulations and charges are increasing the cost while the revenue is controlled with freeze price; therefore, the company has reduced its operating profits. However, diversified investment has resulted in the increased profit margins (Godbold, 2014). Also, company has announced that it will improve the operational efficiencies in the business operations for saving of £100m by the year 2016. Impact of rising cost has affected the ROE and ROCE. Importantly, the company has maintained the system of acquiring debt for meeting its financing needs; however, it also keeps in plan to retire the debt. As a matter of fact, company plans to retire the debt of around £1bn with the disposal of non-core asset and business by next two years from now (Chester, 2014). The strategy is improving the interest coverage ratio of the business. Under the impact of cost and revenue factor, SSE has reduced its earnings for the past two years; however, the company has maintained its dividend at the similar level. The company is following a strategy to deliver its investors with regularly increasing dividends that are covering Retail Price Index (RPI) inflation (SSE Plc, 2014). 2.2 ANALYSIS OF SHARE PRICE TREND The consistently growing share price of the SSE in a relatively smooth pattern (as shown below) also evidence this fact where the share price show fluctuation on events that hurt the interest of the company: Fig 3: SHARE PRICE TREND OF SSE Plc FROM 2010-2014 (MorningStar, 2014b) 2.3-P/E RATIO ANALYSIS Despite consistent trend of Share price, the P/E ratio of the SSE showed followed steep rise:   2010 2011 2012 2013 2014 P/E Ratio 6.05 6.65 52.61 33.50 43.99 Earning 133.9 162 21.1 42.2 33.3 Price 809.71 1,077.29 1,110.08 1,413.82 1,464.93 This steep upward trend after 2012 is not because of the overly excessive positive sentiment of the investors. Instead, investors did not react the decline in the earnings. The underlying reason for this fact as noted by analyst is that the investors have already acknowledged these price factors in the price (Oscroft, 2014). Hence, the P/E ratio of the company rose in upward trend. 2.4- COMPARISON WITH INDUSTRY PEERS Share price as compared to the competitor of the company which includes British Gas (BG Group), National Grid Plc (NG.L) and the E.ON SE (Germany based company) revealed that SSE has managed to sustain the investors’ confidence as evident from the comparison with peers below: Figure 4: SHARE PRICE COMPARISON OF SSE PLC WITH PEERS (Financial Times, 2014b) Belonging to the utility industry, the beta of the company is 0.2688. This implies that company’s share price has little sensitivity with market’s movement. This provides further sustainability in the stocks investment. 3.0. INVESTMENT DECISION The investment decision is affected by large number of factors while main factors are the achievement of objectives. For the achievement of objectives, the investment options are reviewed from the various perspectives. Hence, the recommendations are made on the basis of risk-return as well as an investment ratio of P/E: 3.1. RISK RETURN (PORTFOLIO THEORY FOR DECISION) Each investment in equity has two-sided implications; first, it brings the return to the investor while, on the other, each investment in the equity is subject to a certain level of risk. According to the Markowitz, an investor’s portfolio is efficient in case it can generate maximum return in its class with the minimum risk involved (Francis and Kim, 2013). The risk and return of all three companies are measured as the average return for five years (or average of ROE) while risk is measured with a standard deviation in the ROE for five years. Risk is measured through standard deviation. Standard deviation is widely used as a measure of variability in the series of information. The standard deviation of return provides information about the risk of variability in return (Feibel, 2003). The risk and return all three companies provide the following information:   Average Return For five years (%) Average Risk for Five Years (St. Deviation %)   Wetherspoon (J D) PLC 19.134 3.34697326 SSE 20.306 10.65782952 Next Plc 171.83 18.66559268 The average return for Next Plc is 171.83% for the past five years with a standard deviation of + 18%. Among two options under consideration, it is recommended that Next shall invest in the Wetherspoon as the company has 19.134% but low level of risk while SSE has little higher return which is accompanied by risk of almost equal size. Hence, higher return and lowest possible risk implies that Next Plc shall invest in Wetherspoon in order to increase returns for its shareholders. 3.2. P/E RATIO BASIS OF DECISION The price to earnings comparison of two companies in addition to the Next Plc is produced below for the deciding investment in either of the companies that is able to produce the portfolio meeting objectives of the firm (Next Plc, 2014): P/E Ratio 2010 2011 2012 2013 2014 Next Plc 9.03 8.17 9.54 13.52 16.71 Wetherspoon (JD) PLC 13.26 11.32 13.09 18.94 22.45 SSE 6.05 6.65 52.61 33.50 43.99 The Price to earnings ratio of the Next Plc has risen as a result of the increasing in earnings as well as customer confidence on the company. The objectives set forth by the company to improve business and return cash to shareholders. Consequently, company has been paying special dividends as well (Next Plc, 2014). The P/E of the Next Plc is growing along with an increase in earnings in addition to the consumer confidence on the share. The P/E ratio of the company Wetherspoon (JD) PLC is also growing with increase in earnings while the as noted in the analysis the P/E of SSE is showing massive growth with the reduction in earnings. Hence, it is recommended that the company shall invest Wetherspoon (JD) PLC in order to improve the returns and overall wealth for the shareholders. 4.0. ISSUES IN INVESTMENT Investment for increasing returns and maximizing shareholder’s wealth is subject to various considerations; similarly, it is faced with various challenges. Some of the challenges are discussed as here under: 4.1- AGENCY THEORY According to the Baker (2009), agency theory takes into account the conflict of interest between the shareholders and managers of the firm. For instance, in line with the stated objective of Next Plc of returning cash to shareholders investment in the Wetherspoon may not be acceptable with the investors. The rational for this non-acceptability is the policy of Wetherspoon of maintaining dividend cash at the current level owing to the future capital expenditure. Hence, as an investment in Wetherspoon will not increase the dividend levels of investors of Next Plc there is potential of rising conflict between the investors and management on the matter of investment policy. In the case of any such rising issues, the managers of Next Plc will be required to convince the shareholders with the increasing value of the firm’s share with growth oriented approach. Moreover, with the objective of increasing dividends, SSE is a viable investment option for the Next. However, it has other limitations. For instance, the assessment based on the financials of SSE did not recommend the investment. Second, the major fact of difference lies in the difference in the nature of the industry. The utility industry has its dynamics and management at Next Plc may not always be able to understand the trends in performance, impact of industry dynamics, as well as the huge and influential impact of regulation. Hence, though the increase in dividends being the policy of SSE makes its aligned with the objective of the Next, overall it is not a viable option. 4.2- MISCONCEPTION ABOUT EFFICIENT MARKET HYPOTHESIS The LSE or London Stock Exchange on which these two firms are listed is defined as a strong form of efficiency. This statement is found justified for the fact that share prices have been reflecting the impact of factors that have influenced the performance of the firms such as the share price of Wetherspoon increased massively as a result of event that increased the revenue of the firm etc. However, it is important to understand that such strong form does not mean that market will always estimate the price that is equal to intrinsic value of the firm. According to (Chandra, 2009) strong form of efficient market incorporates all the relevant information only and does not possess any perfection in forecasting abilities. Even the efficient market with strong form is liable of fluctuation in the share price in order to arrive at price that is most close with the intrinsic value of the firm. This fluctuation does not refer to any randomness instead it implies the variability in the reactions of different sets of investors to different news related to the firm. 5.0- CONCLUSION Investment by corporations is required to asses various factors in order to contribute effectively and efficiently effectively towards the set objectives of the firm. The above report has developed an assessment of Wetherspoon and SSE as potential investment options for Next Plc. With the detailed assessment, it has been concluded that Wetherspoon is a viable option of investment for the Next Plc in order to improve the overall shareholders value. Importantly, the decision is supported by various evidences from financial statements, news as well as supporting theories. REFERENCES Baker, H. K. (Ed.). (2009). Dividends and dividend policy (Vol. 1). John Wiley & Sons. BBC. (2012a). Euro 2012 football boosts JD Wetherspoon sales. Available from http://www.bbc.com/news/business-18793006 [Accessed 30 October, 2014] BBC. (2012b). Wetherspoon annual profits boosted by one-off events. Available from http://www.bbc.com/news/business-19596195 [Accessed 30 October, 2014] BFN News. (2013). Wetherspoon Margins Squeezed As Costs Rise. Investegate, Available from http://www.investegate.co.uk/News/wetherspoon-margins-squeezed-as-costs-rise/394891/ [Accessed 30 October, 2014] Chandra, P. (2009). Investment Analysis and Portfolio Management (3/e). Tata McGraw- Hill Chester, G.A. (2014). How SSE PLC Is Changing. 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(2014b). SSE PLC (SSE.L). Available from https://uk.finance.yahoo.com/q?s=SSE.L [Accessed 30 October, 2014] Read More