FPL Group, Inc. is the holding company for Florida's largest electric utility. It has come to the attention of an analyst that FPL has plans of cutting its dividend in the near future despite its constant consecutive dividend increases in the past years. The analyst must come up with a decision on whether a change in the Dividend Policy at FPL Group, Inc. will be a part of FPL's financial strategy.
Benjamin C. Esty; Craig F. Schreiber
Harvard Business Review (295059-PDF-ENG)
March 15, 1995
Case questions answered:
- Why do firms pay dividends? What, in general, are the advantages and disadvantages of paying cash dividends?
- What are the most important issues confronting the FPL Group in May 1994?
- From FPL’s perspective, is the current payout ratio appropriate? Would a higher payout ratio be more appropriate? a lower payout ratio?
- From an investor’s perspective, is FPL’s payout ratio appropriate?
- As Kate Stark, what would you recommend regarding an investment in FPL’s stock — buy, sell, or hold?
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Case answers for Dividend Policy at FPL Group, Inc. (A)
This case solution includes an Excel file with calculations.
Executive Summary – Dividend Policy at FPL Group, Inc. (A):
According to a report by an analyst at Merill Lynch, the FPL Group, Inc. seems to be thinking of a cut in their dividend payout ratio due to which Kate Stark is thinking of analyzing her recommendation about FPL stocks and dividend policy. While FPL might be or want to decrease their payout ratio, the rating should not be based on just the payout ratio and other factors like future earnings, dividend amounts, investments by the company, industry average payout and cash flow should also be analyzed before downgrading or upgrading the rating.
After analyzing the company’s prospective earnings in the next years, we recommend Kate Stark to increase her rating from hold to buy despite the negative image news in Merrill Lynch’s analyst’s report. This stems from the fact that the FPL Group, Inc. has a very low payout ratio currently. And even with a decrease in their payout ratio, by 1998, they will be at the industry average of 80% with dividends increasing every year.
The shareholders will be satisfied too because the company is investing in positive NPV projects which means not only more dividends in the future but also an increase in price per share of FPL (capital gains).
1. Why do firms pay dividends? What, in general, are the advantages and disadvantages of paying cash dividends?
Dividends send positive signals to the market indicating that the firm is performing well and choose to give back the excess cash to the shareholders. This will also reduce the surplus of the excess cash-flow available to managers, thereby avoiding unnecessary spending.
In addition, dividends provide a steady income for a certain type of investors looking for stable payments (widows and orphan stocks) which is known as dividend investing/ fixed-income investing. These type of investors include institutions, pension funds, retirement accounts who do not have any tax preference and prefers a dividend policy that matches their income needs.
Overall, firms pay dividends to increase shareholder value and attract investor groups through a fixed income perspective.
In industries involving high market uncertainty, firms may choose not to distribute dividends…