The Dividend Discount Model (DDM)
An investor analyzes part of a company's financial data before deciding to invest (amounts in USD):
| Data | Year 3 | Year 2 | Year 1 |
|-----------------------------------|----------|----------|----------|
| Total Common Equity | 896,000 | 840,000 | 810,000 |
| Net Income to Common Stockholders | 114,000 | 118,000 | 106,000 |
| Average Shares Outstanding | 525,000 | 548,750 | 497,500 |
| Dividends Per Share | 0.118 | 0.118 | 0.118 |
If the investor only has this information to utilize, the likely reason behind the decision to refrain from investing is:
Incorrect.
The earnings per share, which is net income divided by total weighted average shares, has increased steadily from Year 1 to Year 3. Good profitability is what an investor wants.
Incorrect.
If a company issues dividends, it is important for dividends per share to be stable or growing, based on a company's dividend policy, as investors often rely on a predictable periodic payment. A stable dividend in itself should not be an investor's deterrent.
Correct.
The dividend payout ratio is declining. It is calculated by dividends per share divided by earnings per share (EPS).
$$\displaystyle Dividend \:payout=\frac{Dividends \:per\:share}{EPS}$$
The earnings per share is found by net income divided by number of shares outstanding.
$$\displaystyle EPS=\frac{Net\:income}{Shares\:outstanding}$$
$$\displaystyle Dividend\:payout_1=\frac{0.118}{(\frac{106{,}000}{497{,}500})}\times100=55.5\%$$
$$\displaystyle Dividend\:payout_2=\frac{0.118}{(\frac{118{,}000}{548{,}750})}\times100=54.9\%$$
$$\displaystyle Dividend\:payout_3=\frac{0.118}{(\frac{114{,}000}{525{,}000})}\times100=54.4\%$$
This dividend payout decline pattern is most likely a red flag to the investor. This could indicate that the company is having trouble keeping its dividend payment at USD 0.118 per share.
decreasing earnings per share.
declining dividend payout ratio.
dividends per share not increasing.
