Expected dividend based on target payout

I know that in the end you just learn things the CFA way, but perhaps there is something I’m missing on this topic. (This question is based generically on Mock AM question #30 so it’s a semi spoiler) The company has a dividend of \$.50 from \$2.50 EPS, so their current payout is 20% Then next year’s EPS will be 3.00, and their payout will increase to 40% in five years. Now the answer the CFAI gives using their formula for next year's dividend is .54, but that means their payout actually decreases to 18% even though they’re increasing the payout each year from 20%. How is this logical?

Exp Div Incr = Change in earnings x target payout x adjustment factor The adjustment factor is kicking in to reduce the volatility, so it could be a possible j curve effect? I haven’t really looked into this with that much detail.

the formula is original dividend + [(change in eps)*(target payout ratio)*(1/# of years of change)] 0.54 = 0.50 + [(3.00-2.50)*(0.4)*(1/5)] = 0.50 + 0.04 = 0.54

It’s not change in EPS it’s INCREASE in EPS. If the EPS “increases” by -0.5, you have to multiply by -0.5.

ridgefield Wrote: ------------------------------------------------------- > the formula is original dividend + [(change in > eps)*(target payout ratio)*(1/# of years of > change)] > > 0.54 = 0.50 + [(3.00-2.50)*(0.4)*(1/5)] = 0.50 + > 0.04 = 0.54 Wouldn’t the payout ration be increasing by (0.40-0.20)/5 = 0.04/year, making the next payout ratio 0.24? Ridgefield, where was the formula from?

IARdude Wrote: ------------------------------------------------------- > > How is this logical? Remember the formula and move on. Schweser had some long explanation about how it was logical. But i dont remember it. All you need to remember is the formula.

Question -> Can someone explain how can dividends increase if EPS falls?

dividends is at the management’s discretion. and since dividends mostly do have a signaling effect on the company’s stock price - mgmt might want to artificially prop up share price by paying dividends even though they do not have earnings to show for it.

@CPK, My question was how can you increase dividends based on the targed payout formula when EPS decreases (schweser actually mention this). Thanks anyway. Milos

The targeted dividend payout is based on an expected future dividend payout ratio -

Once again Current EPS = 2.5\$ Current Dividend = 0.5\$ Target payout = 40% Dividend adjustment period = 5 years EPS in year 1 = 3\$ EPS in year 2 = 1.5\$ and the dividend for year 2 is? Thanks

0.5 + (1.5 - 3) * .4 * 1/5 = 0.5 - .12 = 0.38 this is what the calc tells me…

I think you’re a bit off CP, I have: Year 1: .5+(.5*.4*.2)=.54 Year 2: .54+(-1.5*.4*.2)=.39 I thought this was a recursive method, as in we have to have the year 1 div before we can go on to compute year 2 div. If not your answer maybe completely right.

My calc was the same and it seems that dividends will fall. Or we should just do it like CPK did…

In CPs case dividends fall also, they actually fall more than with the use of my method.

no, I did not read completely that there was a 2.5 dividend and you were giving me a EPS 1 and an EPS 2. Sneaky!!! milos and adavydov - you are correct. Year 1: goes up to 0.54, then drops to 0.39.

So, I re-read this part in Schw and it seems that we should only include increases in EPS in the formula above. If company’s EPS decreases or stays the same, dividend will not decline.