7-4. In 1996, Kodak paid a cash dividend of $1.60 per share. At year-end 1996, K

Question

7-4. In 1996, Kodak paid a cash dividend of $1.60 per share. At year-end 1996, Kodak shares were trading at about $80 per share. Between 1997 and 2001, Kodak paid $1.76, and in 2002 raised its dividend to $1.80. Yet, despite the stable dividend payout, the price of Kodak stock steadily fell, reaching $27 in 2003. At that time, the firms announced its intention to reduce its dividend to about $0.50 per share, in order to invest $3billion in digital technology purchases. Investors reacted to the announcement by bidding down Kodak shares by 14 percent. On October 21, 2003, the wall street journal reported that some of Kodak’s large shareholders attempted to persuade Kodak executives to abandon their plan. Discuss this issue.

Explanation / Answer

The market price of any security is not determined by a single factor. Although in simplified valuation models we assume that we can determine the value of the firm based on current dividends and making an assumption about the future dividends. In the initial period of 1996-2003, the share price of Kodak was declining, as it was not able to do well good in the market. The industry in which it was operating was in matured phase or rather in decline phase and there were not enough growth opportunities available.

There are two primary causes for increases in a company’s dividend per share payout. The first is simply an increase in the company's net profits out of which dividends are paid. The second is a shift in the company’s growth strategy that leads the company to decide to expend less of its earnings in seeking growth and expansion, thus leaving a larger share of profits available to be returned to equity investors in the form of dividends.

The two main dividend-related equity valuation metrics investors use to evaluate a company's overall investment potential and specific income investing potential are dividend yield and the dividend payout ratio. While dividend yield is perhaps a more commonly viewed figure by retail investors, the dividend payout ratio is a metric more favored by capital investors. The dividend payout ratio shows the percentage of a company’s earnings being paid to shareholders in the form of dividends. A stable dividend payout ratio over time is considered a favorable sign for investors, as it indicates a financially sound company with earnings adequate to support continued positive dividend yields for investors. Analysts prefer the payout ratio to dividend yield, as a company's current yield may be a figure unsustainable over the long term.

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