The Art of Company Valuation and Financial Statement Analysis: A Value Investor's Guide with Real-life Case Studies

Chapter 6

Profit Distribution Policy

Do you know the one thing that gives me pleasure? It’s to see my dividends coming in.

John D. Rockefeller

 

Outstanding businesses tend to produce excess returns, that is, their earnings exceed their annual reinvestment needs in order to remain competitive. Under the best-case scenario, the company has additional investment opportunities at its disposal in order to reinvest excess capital. If no attractive opportunities are available, remaining free cash flow should be utilized to pay off debt, carry out acquisitions, distribute dividends or buy back shares in order to return capital to shareholders. Also, retaining profits in order to build up a cash cushion or to reinvest the capital at a later point can be a sound decision in certain cases.

Especially the choice between paying out dividends and buying back shares is of great importance for most companies.

6.1 DIVIDEND

One of the possibilities for profit distribution is paying out a dividend. Usually dividends are paid at regular intervals and their amount is often determined by available profit for the period. In the US, quarterly dividend distribution is common practice, whereas most European companies distribute profits on an annual or bi-annual basis.

Depending on the industry and business type, the observed payout rates differ considerably. Growth businesses, which require their excess income to fund further growth, often forgo dividend distribution. In contrast, well-established and ...