Question

What is the payout policy of a company who is paying no dividends for the last 5 years and the companies diluted earnings per share for last 5 years is also zero or negative. We need to determine payout policy only on the basis of the payout ratio, so how can we describe the payout policy when there is no dividend, no diluted earning per share?

Answer 1

Diluted earnings per share

The process of estimating the quality of earnings per share of a firm by exercising all convertible securities of that firm the value of diluted earnings per share can be ascertained. All outstanding preferred shares, debentures, stock options and warrants, convertible in nature can be used to estimate the quality of earnings per share.

Payout ratio is also called dividend pay-out ratio it shows the relationship between general stock holders and the amount of dividend declared to pay such stock holders.

Dividend is paid after the payment of tax and disbursement of the amount to preference stock holders. Generally there are two types of formula to determine payout ratio

Formula 1 Payout ratio = Total DividendCash dividendpaid to equity stock holders Total Net profit of the stock holders ˣ 100

Formula 2 Payout ratio= Dividend per ordinary stock Earnings per share ˣ 100

Retained earnings of the firm is 100% - % of payout ratio

In the given problem it is mentioned that diluted earnings per share is nil. Other Information is that there is no dividend found in the EPS determination procedure. It can be happened if after payment of taxes and preferred stock holder there lies no profit. It means the Payout ratio is 0%. Therefore, no amount is there either to retain the profit or to declare the profit as dividend.

In such a case the value of the stock must be declined very badly in the market as no party will become interested to buy the stock of such firm that fails to declare dividend to its stock holder. It means stock holders are not able to earn anything against holding the stock of the firm.

Another situation might be happened the firm has made the profit after the payment of taxes and preferred stock holders. Afterwards retain the remaining profit in order to use it for the future purpose of development. It means in lieu of declaration of dividend the Firm block the sum and makes capital appreciation. Such capital appreciation may lead to increase the price of the stock in the market.

To make the payout ratio zero percent the policy of the firm may be

• To increase capital appreciation and make the stock price costly.
• To retain the profit by not declaring dividend in order to use it for future development or to use it for business extension.
• when the distributable profit is retained over the years it helps the firm not to opt for borrowing the amount from the outside sources when fund is required in the business. Borrowing means repayment of the borrowing amount with interest. By retaining the profits and making the payout ratio zero percent the firm is actually kept aside the sources of outside borrowing.

• If it is assumed the firm is new and has been in the operation for the last five years only. Therefore, to set up the business the firm has incurred lots of money hence such retention of profit compensates such huge expenses incurred by the firm for the last five years.
• The firm may opt for dividend irrelevance strategy where the stock holders are least bothered about receiving the dividend amount because when there is a requirement of liquid money they may easily collect the money by selling their holding portion.