As shown in the Table 1 below, it can be seen that the Earning per Share (“EPS”) for Tesco is gradually increasing for the past five years, which had increased from 20.30 pence in the year 2006 to 31.82 pence in the year 2010. Consistent with that finding, the dividend per share for Tesco has also been increasing gradually throughout the years. It is found that the dividend per share for Tesco had increased from 8.63 pence in the year 2006 to 13.05 pence in the year 2010. However, a pure review of the dividend per share and earnings per share trend for the company cannot reveal much about the dividend policy employed by Tesco. Thus, the dividend payout ratio for Tesco is calculated. As shown in Table 1, the dividend payout ratio of Tesco is roughly consistent, and it is ranging in the range of 40% payout ratio. Practically speaking, this means that around 40% of the earnings for a certain financial year will be paid out by Tesco to the shareholders, while the remaining of the 60% of the earnings will be reinvested for further growth of Tesco in the future. Upon understanding of such issues, the practical considerations of Tesco dividend policy can be discussed. Specifically, in the next few paragraphs, it will be discussed if the dividend policy of Tesco relevant, and if it is a viable dividend policy.
Table 1: The Dividend Policy of Tesco
Source: Adapted from Annual Report
Firstly, I can be seen that the management had been holding the payout ratio constant. Such a consistent ratio of payout ratio can deliver a sense of certainty to the investors. When the investors understand that the dividend payment is proportionally linked to the earnings, they will more likely to like the company if they are those type of investors demanding certainty in dividend payment. In other words, such kind of dividend policy will attract certain types of investors, and these types of investors are those that demand steady dividend income from the stock that they purchase. In many cases, these investors can be those conservative, income oriented investors, who are mainly retirees. In other words, this means that such a dividend policy, when being implemented in a constant manner, can be beneficial to the stock prices. It is more likely for investors to place price premium on the share prices of Tesco, due to the sense of constancy and stability bring forward by the dividend policy. Essentially, wealth is created through the constant payout ratio.
Such a dividend policy is also practical in the sense that management does not need to continuously revise the dividend policy, as the dividend policy is a simple and clear cut one. Due to the simplicity of such policy, management does not need to spend time managing the dividend policy, and instead can allocate more time to those truly important facets of managing a business. For example, the management can focus more on growing the business, managing the risk faced by the business operations in the oversea markets or to continuously strengthening the competitive advantage of the firm in the increasingly challenging market environment.
Besides, as Tesco is a constantly and continuously growing company, the dividend payment is also growing steadily. The constant dividend payout ratio enables the investors to receive a constantly increasing dividend amount. Such a phenomenon will greatly enhance the share prices of Tesco, as generally speaking, the sign of increasing dividend payment is a positive news to investors, as it indirectly imply that the management is optimistic about Tesco’s profitability in the future. In fact, it is not hard to expect that such a situation may attract several types of investors to the company. For example, growth-oriented investors may be attracted to invest in Tesco because of the growth opportunities, while the income oriented investors will likely to love the steadily dividend payment offered by Tesco. This means that Tesco will be more frequently talked about by the investment fraternity, and the publicity and popularity of Tesco may even generate a price premium for the firm in the financial market.
However, there may also have certain argument that such a high dividend payout ratio for Tesco is no justified. After considering the financial position, particularly the capital structure of Tesco, it is found that Tesco has been using more and more leverage. This means the debt burden on the firm is becoming more serious in the recent years. From a review of the annual report of the company, it is understood that the usage of higher debt is required in order to grow the company. In other words, this means that Tesco has been relying more on debt, instead of internally generated fund to grow the business. Thus, it is very questionable if the management must use debt for such purposes, and if the dividend payout ratio should be maintained at such a high level. Logically thinking, it will be much better if the dividend to be paid out to be reinvested in the company, so that less debt will be required to be raised by Tesco for further business expansion purposes. This is because the debt usage can be risky, particularly in times of financial crises. When the economy goes down, the high interest burden from debt instruments may cause the firm hard to service its debt.
Besides, it can also be argued that the price premium derived from high dividend payout ratio may not be sufficient to offset the negative pressures from increasingly usage of debt by Tesco. As the firm use more and more debt, it is likely that the investors perceive that as risky move by the management. Thus, stock prices may be affected negatively. Thus, it is possible that the dividend policy currently followed by the firm is now may not structured to maximize the shareholders’ wealth, as relying on high debt usages in the firm can depress the share prices, or to increase the share prices volatility.
Besides, practically speaking, as Tesco is proven to be able to growth at such a fast rate, it is acceptable for the firm to reinvest most of the earnings, by having a lower dividend payout ratio. With this, the company can be benefited in the long run. In fact, at current stage, from a longer term perspective, it may be beneficial for the management to reduce dividend payout ratio to repay the debt. This will definitely reduce the financial or liquidity risks faced by the firm, and to ensure the financial health of the company is protected in the long run.