Dividend Policy and Stock Returns of Bata Shoe Company - Case Study Example

Qatar University Report On the Dividend Policy and Stock Returns OF Bata Shoe Company (Bangladesh) Name Date Words (2730) Executive summary The report reviews the Bata shoes company Bangladesh equity finance to establish a trend of which dividend policy and stock return policies it ascribes. From the review, we found that the company utilized different dividend policy payout to meet different needs. During the 2006 and 2007, the company had high cash dividend payout, which is consistent with the bird in hand, theory where they were attracted because of the high dividend payout. However, in the succeeding years the company adopts retention of earnings consistent with the irrelevant theory of divided policy. This is assumed to have taken place to preserve funds that were to be used for future development. It was noted that the company might have been able to attract more investors over the period of 2006 and 2007 and in retaining earnings during 2008 and 2010, the company was perceived to be stable regarding its financial base. Attracting and retaining the customers happened although no cash dividends were paid out resulting in a rise in the overall price of Bata Company Bangladesh in the stock market. The report recommends that the company in the succeeding year should implement the irrelevant theory of dividend policy through retention of policy for future growth. Contents Executive summary 2 Introduction 3 Dividend payout ratio 9 Dividend payout and retention 9 Comparing the year ended P/E ratio in the 5 years (2006 - 2010) 11 Introduction Dividend and stock return have a significant effect on the behavior of the stock prices in the market. This is dependent on the adopted dividend policy within a company. This is done in a bid to attract different types of investors to invest in a company that needs capital for future growth. Bata Shoe Company has been in existence since 1894 and was founded by businessman Thomas Bata in Czechoslovakia in Zlin city. The company has been the outcome of a shoemaking family in which the hundreds of years of experience was consolidated to that to found the company. Bata Shoe Company has operations in more than 70 countries globally and serves over a million customers each day. The Bata shoe company Bangladesh has been listed on the Dhaka and Chitta stock exchange (Bata Shoe Company website). Dividend theories Dividend Irrelevance Merton Millar and Franco Modigliani (M&M) suggest in the ideal world, a firm’s value is not affected by the dividend distribution rather it is determined by the power of earnings as well as the rise a company’s assets. Bata shoe Bangladesh does not ascribe to this school of thought. Bird in hand theory The bird in hand theory developed by Myron Gordon and Linter suggest that shareholders have a preference on current dividends. The theory explains that there is an association between dividend policy that a company implements and the market value of that of the company stock (Al-Malkawi et al., 34). The main principle of the bird in hand theory is those investors are risk averse and find the present less risky as opposed to the future gains and dividends that could be realized in the future. Analysis and evaluation By reviewing the Bata shoe company’s financial data for a period of five years from 2006 to 2010, we can determine the dividend policy that the company utilizes. Table 1 below shows the dividend %, stock price and net income for Bata Shoe Company from year 2006 to year 2010. Year % Dividend Stock Price in DSE (TK) NET INCOME(TK) 2006 235.00 121.4 277,022,059 2007 250.00 223.6 324,849,273 2008 220.00 320.70 449,415,702 2009 220.00 528.30 449,406,445 2010 250.00 645 543,970,530 Table 1: Dividend %, Stock Price and net Income for the Bata shoe company From the data of Bata Company since 2006 to 2010 stock price and dividend ratio, one can tell that in the company ascribes to the bird in hand theory. A company can declare high dividend payout to its shareholder because of the-the following reasons: 1. The shareholders have a preference of the current dividend. 2. There is a direct associate between dividend policies that a firm adopts and the value f the share in the market. 3. The investors are found to be risk averse and are of the opinion that current return is less risky as opposed to future dividends or capital gains. 4. Investors also believe that a bird in hand is worth two in the bush. 5. Giving cash dividends is attributed to a reduction of uncertainty. However, there is a lower rate of return on investment. 6. There is a failure in providing conclusive evidence that would support the argument regarding the relevance of that dividend. 7. Financial managers, as well as shareholder, hold the belief that those dividends are relevant. Using this principle, we realize that Bata Shoe Company implements the Bird in hand theory. This is evident as they declared a higher dividend and retained fewer earnings so as to attract the investors who are risk averse and who prefer cash dividends and who share the believe that higher declaration of dividends has a minimizing effect on the uncertainty of the company’s performance (Chowdhury, 3). This consequently allows the share prices to rise to a level that is set as the payout ratio, which is one of the indication of the implementation of that Bird in hand theory of dividend policy. Dividend Policies Constant payout ratio A constant payout ratio is a dividend policy ratio that indicates the percentage of every amount distributed to the shareholders in cash form. The calculation formula of dividend payout ratios is: Through this formula, a constant payout ratio dividend policy is established in which a particular percentage of earnings is paid to the shareholders every dividend payment period. However, there are shortcomings associated with the payout ratio policy where if a company were to earn a loss in a given dividend payment period the dividend may be negligible or not existent. This consequently would affect eh firm’s stock prices. Regular Dividend policy This kind of dividend policy ascribes to paying a fixed amount of that dividend for every payment period. The policy mainly payouts to the shareholders when there are positive dividend returns thereby minimizing the uncertainty of the market share prices of the company stock. One finds that many firms adopt the regular dividend policy and increase the amount to dividend payable in a certain period with an increase in earnings. Under this policy, dividends are never decreased. Low Regular and extra dividend policy In some case, companies adopt a low regular and extra dividend policy in which they pay a low regular dividend, which may be supplemented by follow-up dividend known as an extra dividend. In this case, the firms avoid giving shareholders any false promises and adopted by the company that normally experience cyclical shifts in earnings. Assessment of company growth in 2006 – 2010 Year Net income and growth YEAR NET INCOME(TK) GROWTH (%) 2005 206,638,315 ----- 2006 277,022,059 (277,022,059 - 206,638,315) / 206,638,315 * 100 = 34.06% 2007 324,849,273 (324,849,273 - 277,022,059) / 277,022,059 * 100 = 17.26% 2008 449,415,702 (449,415,702 - 324,849,273) / 324,849,273 * 100 =38.35% 2009 449,406,445 (449,406,445 - 449,415,702)/449,415,702 * 100 = (0.00206)% 2010 543,970,530 (543,970,530-449,406,445)/ 449,406,445*100 = 21.04% Table 2: Net income and its growth in the period 2006 to 2010 Discussion One finds that growth in the net is a vital element of sales since the net income can inform the investors how much profit is gained with the exclusion of the operating costs from the sales revenue. The above table presents the Bata shoes Bangladesh profit earned between 2006 and 2010. We see that in the year 2009, there was a negative growth standing at 0.00206 percent of profit. It seems that the 2009 recession had affected the growth of the company negatively as it was a global economic phenomenon (DeAngelo et al., 56). At this time, the customer behavior changed in which consumer only bought the essential items rather than footwear. Additionally, there was electricity shortage in Bangladesh that affected production thus resulting in a negative growth. Earnings per share Earnings per share (E.P.S) can be described as the money earned by the company, which has been expressed in terms of earnings for every share that is owned. It is important to review the EPS of Bata Company to analyze the trend of earning per share. In a review of the EPS from 2005 to 2008 we notice that an increasing trend in EPS however not in equal percentage for each year (Copeland et al. 76). YEAR EPS GROWTH (%) 2006 20.25 20.25 - 15.11 / 15.11 * 100 = 34% 2007 23.75 23.75 - 20.25 / 20.25 * 100 = 17% 2008 32.85 32.85 - 23.75 / 23.75 * 100 = 38% 2009 32.85 32.85 - 32.85 / 32.85 * 100 =  0% 2010 39.76 39.76- 32.85 / 32.85 * 100 =  21% Table 3: EPS and its growth between 2006 -2010 Discussion The table above show that EPS is has an increasing trend for each period in review, which is found to be a good trend of the company as well as the shareholders. Bata Bangladesh Dividend information Dividend payout ratio Using the dividend payout ratio one can evaluate the percentage EPS that is paid out as dividend. Additionally, one can determine that whether the payout follows a dividend relevance theory or an irrelevance theory of returns. YEAR (1) CASHDIVIDEND PERSHARE (2) EPS (3) DIVIDEND PAY OUT RATIO (4)= (2)/(3) 2006 23.50 20.75 113.25% 2007 25.00 23.75 106.26% 2008 22.00 32.85 66.97% 2009 22.00 32.85 66.97% 2010 22.00 39.76 55.33% Table 4: Dividend Payout ratio (2006 to 2010) Discussion In the table above, we find that dividend payout ratio has a decreasing trend each year, which is because of the cash dividend payout even though the EPS is high. From this information, we find that Bata might be retaining earnings in order to have capital to implement future expansions. Dividend payout and retention YEAR Dividend payout ratio Retention ration (1-payout ratio) 2006 113.25% 0% 2007 106.26% 0% 2008 66.97% 33.03% 2009 66.97% 33.03% 2010 55.33% 44.67% Table 5: Dividend Payout ratio and retention ratio 2006 to 2010) Discussion We find that from the above table 2006, and 2007 had a retention ratio of zero however the Bata shoe firm had a retained 33.03 percent on the earning within the period in 2008 and 2009. Additionally the retention percentage was increased in the succeeding period d in 2010, which stood 44.67 percent. This shows that in the 2008 to 2010 period the irrelevance of dividend theory was being implemented to achieve future growth. Stock dividend In the analysis of the stock dividend in the 2006 and 2010 period, we realize that Bata Shoe Company did not declare stock dividends to its stockholders. Dividends are often paid if a company at the time when the company requires retaining funds to finance rapid future growth (Banerjee et al., 20). The fact that Bata has a strong financial base and numerous ways of raising funds, we see that sometimes it prefers to issues cash dividends over stock dividends to send a positive indication to investors that the company is financially stable. Its strength is seen through its ability to finance growth without relying on retained investment from its shareholders thus causing an increase in share prices in the stock market during the five-year period. Year % Dividend Stock Price in DSE (TK) 2006 235.00 121.4 2007 250.00 223.6 2008 220.00 320.70 2009 220.00 528.30 2010 250.00 648.00 Table 6: Dividend Payments in percentage form Discussion: As the table above indicates, there is an attractive cash dividend payout. This process may be assumed as a way for Bata to attract a greater number of investors in the company. To this end, Bata Shoe Company create positive indicator by giving out high dividend payouts. It is evident that the incentive worked to attract more investors by assessing its annual increase in the prices of its stock in the market. Comparing the year ended P/E ratio in the 5 years (2006 - 2010) Year  Year End P/E % Dividend  % Dividend Yield  2005 8.22   120.00 8.06          2006 6.00   235.00 19.36          2007 9.42   250.00 11.18          2008 9.76   220.00 6.86          2009 16.08   220.00 4.16          2010 16.46   250.00 3.83          Table 7: P/E ratio (2006 to 2010): (Chowdhury, 10) Discussion In the table above, one finds that the annual P/E ratio has continued to increase during the six-year period that indicates a good sign for growth in the future as well as prospect for the firm. This has the effect of attracting investors to continue investing in the company. Conclusion In the five-year period (2006 -2010) we find that during the 2008 and 2009, the company had an average of 63.09 percent of dividend payout from their net income. In 2006 and 2007 period, the payout averaged 113.25 and 106 percent respectively which is more that the net income that the company had realized in the same period. The retained earnings that were used to finance the extra dividend payout over and above the net income. Based on the dividend theory one can assume that the reduced dividend payout ratio may be predicted t lead to a lower price of stock in the market. However, in the view that the stock prices did not drop, this can be assumed that the management convinced the shareholders that the reduced payout was attributed to the recession and that the retention of earning in order to fund future growth (Banerjee et al., 76). As a result, we find that the stock price continues to go up. This can be referred to as the clientele effect that is meant to attract the more investors that appreciate the dividend policy that is being implemented in a particular period. If the targeted investors prefer high dividend payout, then the company’s that has to payout high dividends to investors. Subsequently, when the investors targeted prefer retained earning seen through stock dividend payout the company must therefore retain more investments. We find that for many of the Bata shoes investors prefer dividend payment since the company has a small number of wealthy investors. We can conclude that Bata Shoe Company used the bird in hand theory of dividend policy by looking at the rationality of investors would prefer current returns on investment over future earning from retained earning therefore for the first two year in examination (2006 and 2007), the company paid out higher amount of cash dividends. However, it can be assumed that after attracting more investors, it then reversed its dividend policy to adopt the irrelevant theory of dividend payout where earning are retained. The Bata Shoe Company Bangladesh needs to continue following the irrelevance theory of dividend payment to ensure future growth. Furthermore, any particular dividend policy can be used to attract the investors depending on their preference short-term returns or long-term returns. Works Cited Al-Malkawi, Husam-Aldin Nizar, Michael Rafferty, and Rekha Pillai. "Dividend policy: A review of theories and empirical evidence." International Bulletin of Business Administration 9.1 (2010): 171-200. Banerjee, Suman, Vladimir A. Gatchev, and Paul A. Spindt. "Stock market liquidity and firm dividend policy." Journal of Financial and Quantitative Analysis 42.02 (2007): 369-397 Bata Shoe Company Ltd Website. Retrieved November on 19, 2015 from http://www.batabd.com/about-us.html Brealey, Richard A. Principles of corporate finance. Tata McGraw-Hill Education, 2012. Copeland, Thomas E., John Fred Weston, and Kuldeep Shastri. "Financial theory and corporate policy." (2005). DeAngelo, Harry, Linda DeAngelo, and René M. Stulz. "Dividend policy and the earned/contributed capital mix: a test of the life-cycle theory." Journal of Financial economics 81.2 (2006): 227-254. Rashid, Afzalur, A. Z. Rahman, and M. Anisur. "Dividend policy and stock price volatility: evidence from Bangladesh." Journal of Applied Business and Economics 8.4 (2008): 71-81. Read More