expected dividend = (previous dividend) + [(Expected Increase in EPS)x(Target Payout ratio)x(adjustment dactor)] where adjustment factor = 1/number of years of the adjustment
Not only does this thing move you away from the target payout it also becomes meaningless if there is no expected increase in EPS. What am I missing??\
Here’s a an excel output for the case in point:
5 years for the adjustment factor $0.7 current dividend** $3.5 current EPS **$1 increase in EPS every year 35% TARGET payout ratio…
EPS Year Dividend Payout Ratio
3.5 0 0.7 20%
4.5 1 0.77 17%
5.5 2 0.84 15%
6.5 3 0.91 14%
7.5 4 0.98 13%
8.5 5 1.05 12%
The stable dividend policy is based on long term sustainability independent of cyclical/volatility of earnings. It’s meant to give certainty in regards to the level of future dividends. So, even though the payout ratio might not reach the target in the near term, it’s expected to reach its target given the company’s long term forecast of earnings. The main/important point is that the amount of dividend doesn’t fluctuate and follow up and down swing patterns in earnings.
Dailygrind, thank you for your answer, however I still fail to understand the logic of this formula.
Even if we were to only care about the long-term, it looks like the payout ratio moves towards zero with every increase in earnings and just remains stable when no Earnings difference is expected.
Evidently, the “target payout ratio” is completely unattainable and any “stability” at play really is the stable obsolescence of the ratio.
EDIT: The argument about long-term convergence towards the ratio would make some sense, if we were to keep increasing the dividend even without an expected increase in earnings… Is this the case by any chance?
Someone might have to answer the first part for you. Best of my knowledge, in the long long term like I wrote in my first post, it is suppose to merge. I’m not too worried about the details. It’s more critical to know that the stable dividend policy is to show consistency/sustainability in dividend levels when earnings are volatile and fluctuate. If you wanted dividends to reflect the cyclical nature of the business, it would have chosen a constant dividend payout ratio policy.
To understand the utility of the model, try using negative earnings growth mixed in with positive earnings growth (in otherwords, remove the trend in earnings - just let them grow and shrink from year to year). Pls report back your results.