Dividend Forecasting

Companies that are financed fully or partially through equity financing face a difficult decision as to whether to issue an interim or final dividend to their shareholders. For some companies that decision is easy to make as they do not have a profit from which their dividend can be paid, but for others it is a tough choice which can impact on the future development of the company. But the question today is not whether a dividend should be issued, but actually how important is dividend forecasting?

I work for a company which is jointly owned by two large multinational firms, both of whom have provided equity finance to allow us to grow and expect dividends in return. Last year was the first year in approximately ten years that we, as a company, have been able to issue a dividend to our shareholders. The reasoning behind this is largely due to the fact we have not been able to make a profit and not because we have chosen not to.

The problem we face as a company is that we have been forecasting significant profits over the last few years which should have resulted in dividend payments, however upon final completion of our end of year accounts we’ve actually made significant losses. The reason behind this is due to the large extent of accounting standards we have to report in, and the need to report in a certain way for one of our parent companies. To combat the problem, a project has been developed which will allow us to report monthly our financials under the set of standards upon which our dividends will be based, rather than only looking at them in this format at the end of the year. The hope is that this will allow for more accurately profit forecasts and thus more accurately forecast dividends. But whilst we work on this project, the question could be raised as to whether this is actually a worthwhile project? Do shareholders actually need to be informed in advance whether they will receive a dividend or not?

From a shareholders perspective it could be argued that yes accurate forecasting as to dividend payments is needed. Their aim is to maximise their wealth and if they cannot be seen to receive a dividend for the current financial year or for the next (depending on how accurate the forecasting is), is their investment actually worth it? But ultimately this depends on the type of shareholders who have invested. Pension and insurance companies who are looking for regular returns upon their investments would prefer this as they can pull out of investments that are no longer going to be beneficial to them. But in our position, where both our shareholders are large multinational organisations looking to help us grow and develop, would they not be happy with a statement at the end of the financial year which said why they didn’t get a dividend rather than continuously changing forecasts?

Looking at the issue from a company accurate dividend forecasting will be useful as it will allow for the company to make decisions in advance as to whether to issue a dividend and be prepared to factor this outgoing cash into their plans for the rest of the year, and allow for the company to decide whether it is worth issuing a dividend or whether that money would be better spent on R+D so as to maximise wealth in the future. But due to the time and cost taken to produce these forecasts and make these decisions regularly, is it really worth it?

In my opinion, yes it is worth it. Dividend forecasting for the reasons discussed will keep both the shareholders and management of a company happy. Shareholders who know the circumstances they are facing will be kept satisfied, whereas those who don’t will be more inclined to invest elsewhere where the knowledge is more readily available or the investment is guaranteed to be worthwhile. As a company, better forecasting and cash planning can only be a good thing if we are too keep our shareholders happy and if we can plan in advance whether the money can be better used in other aspects of the business we can forewarn our shareholders what investments we are making which may affect their dividends, rather than use a backward looking approach to the matter. But as with everything, circumstances changed and it should be emphasised that although dividend forecasting is a good thing, it should not be relied upon as the confirmed truth.

Is there such a thing as a strong capital structure?

In November 2012, Moody’s cut the triple A-rating of the ESM recuse fund by one notch and gave the rescue fund a negative outlook. The reasons behind this being that the agency felt that ESM would not fulfil its financial obligations. However Moody’s were criticised for their approach by the managing director of the ESM who argued that Moody’s did not acknowledge ESM’s exceptionally strong capital structure. But is there such a thing as a strong capital structure and should this actually make a difference when considering credit ratings?

The traditional view on capital structure argues there is an optimum capital structure at which the WACC is the lowest possible. This is caused by altering the levels of debt and equity within the organisation. But there is no argument to suggest whether this is optimum level equates to a strong capital structure. Having an optimum WACC indicates that up to that point in time, gearing will increase shareholder wealth, whereas anything after this point becomes risky and will see a decrease in share price and shareholder wealth. But does this mean it is strong? Well yes and no. It could be suggested that this optimum point is strong because organisations have been willing to lend to this organisation and have no financial worries about the company, and shareholders have seen potential in the company’s future growth opportunities, but if they are at this point where can they go from here? Is the strongest point therefore not at a point before this optimum level where a company has the opportunity to raise finance from both a debt and equity position?

However, in the 1950s Modigliani and Millar presented a paper which suggested that capital structure has no impact on WACC and therefore no optimal structure exists. So, if no optimal structure exists does a strong structure exist? Well this argument is very similar to that considered in the traditional view. If you are in a position where you are able to finance both through debt and equity without damaging overall value then yes you could be seen to be in a strong position. If your structure does not allow you to finance through debt or equity then it could be argued that you are in a weak position.

Ultimately the conclusion as to whether a company has a strong capital structure or a weak one is dependent upon whoever is making viewing that company at that point in time. A shareholder might argue their company has a strong capital structure when it is providing them with the most wealth; a lending company on the other hand might view a strong structure as one which minimises risk. Therefore it could be seen that Moody’s were right to base their decision excluding an analysis on capital structure as the strength of the capital structure changes depending on who is making the analysis and what their view point is on a strong structure.