Dividend Practices and Policies - Report Example

Family Dollar is one of the retail chain stores in US providing low overhead, self services to retail s. Over the period of time, its dividend policies remained focused on providing consistent payouts in the form of dividends to its shareholders. Such strategy may be good for achieving the short term objectives of the firm but to obtain its long term vision, it must look for more conservative approach and improve upon its existing base of earnings to fund its long term expansion through internal sources of funds. Family Dollar- a brief Introduction Family Dollar is one of the retail chain stores in US with an aim to provide low overhead, self service retail stores. Beginning in 1959, in North Carolina, Family Dollar became one of the largest retail store chains in US with more than 6600 stores all over US. Family Dollar claims to be one of the fastest growing retail chains in the country due to its unique concept and ease and convenience that it provides to its customers. With low prices everyday, Family Dollar is also forging ahead as one of the strongest retail brands in US. Over the period of last five years, it has added more than 4000 stores to its total portfolio mainly due to its unique merchandising strategy offering similar neighborhood type of experience while doing shopping. Its collaboration with major brands of the world further provides an opportunity to position itself as one of the most important retail chain stores in country. The stock performance over last 52 weeks indicates a stronger performance in the market as the stock went on to touch highest market price of $35 whereas lowest market price during this period remained at $19 with total market capitalization of more than $ 3 Billion. The major aim of this research paper is to identify and explain the dividend policies and practices of Family Dollar and than make an assessment of its dividend policies in order to understand and identify its strengths and weaknesses. Dividend Policies and Practices One of the most important indicators for the financial performance of a company is its ability to pay dividends to shareholders. Dividends are the returns which a company pays to its investors for investing their funds into the business. Investors often consider dividends as the strongest signals to market regarding the capability of the firm to produce consistent stream of cash flows for the shareholders.(Desai & Hines,2002). Since price of an stock is determined by discounting the future cash flow streams of the firm i.e. dividends is the only major cash flow which shareholders receive, therefore it is critical that the firm must produce a consistent stream of cash flows in order to keep the confidence of investors intact. This is despite the fact that theoretically, it has been often argued that dividends and dividend policies do not matter and are irrelevant.(Magni, 2004). There are various dividend policies that companies adapt during the course of their business as such policies largely depend upon the ability of the company to consistently pay out the dividends. Major types of dividend policies include providing consistent payouts either in the form of cash or stock splits. These policies often depend upon the ability of the firm to pay off dividends in most consistent manner thus constantly relaying a signal to the market regarding the ability of the firm to pay returns to shareholders. A close look at the dividend policies of the Family Dollar would indicate that the firm has been able to consistently increase its payout ratio for the last thirty years or so. Over the period of last thirty years, Family Dollar has paid regular cash dividends with consistent increase in the payout ratio. It has also paid stock splits as the dividends also however, that practice has been discontinued since 1998 when company offered stock split for the last time in a decade. Since 1998 it is paying regular cash dividends at an increasing payout rates. Recently, it has also increased its dividend payout ratio despite the fact that US economy faced recessionary trends (retuers.com,2009). Strengths and Weaknesses of Dividend Policies Agency theory often postulates that the external shareholders often expect higher cash dividends because it reduces the chances for managers to manipulate the cash of the company. (Baker & Kolb, 2009). Thus shareholders often attempt to reduce the opportunity cost of allowing managers to take decisions which are mostly in their own interests rather than in the interests of shareholders. From this perspective, it is therefore clear that the dividend policies of the Family Dollar are designed in a manner to attract the interests of shareholders. The major strength of such strategy lies in the fact that it continuously provides a positive signal to the market and hence the overall confidence of investors remains positive. It is also important to note that a consistent increase in payout ratio may also indicate the fact that company is not re-investing major portion of its earnings back into the business for achieving growth. It is probably because of this reason that the Family Dollar generally remained stagnant in terms of opening new stores and its major expansion occurred during last five years. Recommendations Based on the literature review as well as the consistent payout trends, it is important that Family Dollar must adapt a more conservative approach in terms of its dividend policy. The recent trends indicate that the firm’s expansion has occurred mostly during last five years and it has continued to pay increased dividends even during the period of recession in US. As such, this policy may hamper the growth of the firm and the firm may not be able to obtain funds at relatively lower cost in future. Conclusion Family Dollar works in an industry where internal cash flow generation is relatively more stable because most of the transactions takes place on cash basis therefore as for as future cash flow generation capacity of the firm is concerned, it is stable and more predictable. Utilizing its strengths, Family Dollar shall attempt to engage itself into more aggressive expansion and must shade-off its label of being a local retail store. It must expand outside of US and in order to achieve this objective, Family Dollar has to rely more on its retained earnings rather than procuring funds from external sources. Overall, the dividend policies of the firm are largely focused on achieving short term objectives rather than long term goals of the firm. Existing Policy therefore may not allow firm to achieve its long term growth objectives achieved at relatively low cost and with more stable and predictable internal sources of funds. References 1. Baker, Kent, & Kolb, Robert (2009). Dividends and Dividend Policy. New York: John Wiley and Sons. 2. Magni, Carlo A (2004). Relevance or irrelevance of retention for dividend policy irrelevance. MPRA, 07(5591), Retrieved from http://mpra.ub.uni-muenchen.de/5591/1/MPRA_paper_5591.pdf 3. Reuters (2009, January 15). UPDATE 1-Family Dollar raises dividend, shares jump. Retrieved from http://www.reuters.com/article/rbssConsumerGoodsAndRetailNews/idUSN1553662520090115 4. Desai, Hines, & Mihir James (2002). Dividend Policy inside the Firm. NBER, Retrieved from http://www.nber.org/papers/w8698 Read More