In this part of our report, we come to the dividend policy of Tesco Group. The dividend policy is in effect linked to the interest of the investors. Good and divined policy can attract more investors and for analogy; poor divined policy can lost investors and consequently affect the market value and share prices of the company. We look at three schools of theory on dividend policy. The dividend irrelevance school suggests that dividend policy does not matter as expected, due to its faint linkage to the firm value.
That is, if a firm's investment policy (and hence cash flows) doesn't change, the value of the firm cannot change with dividend policy. This thought has two assumptions: an investor does not have to pay tax when receiving dividends and if a firm pays too much in cash, it can issue new stock, with no flotation costs or signaling consequences, to replace this cash. The second school suggests that dividend policy is bad for the average stockholders because they have to pay tax when receiving dividends.
However, in opposition to the second school, the third group argues that if stockholders like dividends, or dividends operate as a signal of future prospects, dividends are good for stockholders and can boost the value of the firm (Hyderabad, 1997). Back to Tesco's case, it is primary to test the relationship between the value of the firm and the dividends of firm for the last five years, namely from 2002 to 2006. We use EXCEL to calculate the covariance between firm value and dividends, variance of firm value and variance of dividends.
The equation is expressed as follow: Figure 5 calculation of correlation between firm value and value From figure 5, the Tesco's value and its dividends are highly correlated, marked with a coefficient 0. 987. This result strong supports that third school of theory on dividend policy: if stockholders like dividends, or dividends operate as a signal of future prospects, dividends are good for stockholders and can boost the value of the firm. Evidently, the increase in dividends does have a substantial positive impact on the firm value of Tesco for the past five years.
In addition, in order to analyze the dividend policy of Tesco more specifically, we introduce another technical method into our analysis – time series estimation of the change of earnings per share and dividend per share. By definition, time series estimation is the use of a model to estimate future events based on known past data: to estimate future data points before they can be measured. The typical example is the opening price of a share of stock based on its past performance. In this report, we use the statistical software EVIEW to estimate earnings per share and dividend per share of Tesco in 2008 and 2009.
The estimation method is auto-regressional estimation. The results of the estimation are shown in table 6, figure 7 and figure 8. For last five years, the dividend policy of Tesco attempted to increase the distribution volume, which was coupled with the growth of earnings per share (table 6).
Earnings per share increased from 12. 05p to 22. 36, or by 12%, 11%, 18%, 14% and 11% respectively. Dividends increased from 5. 6p to 9. 64p, or by 11%, 10%, 11%, 14 % and 12% respectively. In the future, says 2008 or 2009, earnings per share will increase to 24. 54p and 26. 58p, or by 10. 5% and 8. 3%; dividend per share will increase to 10.4p and 11. 18p, or by 9. 4% and 10. 8%, which are smaller than the historical growth rate.
The future trend of dividend shows that the increase of dividends will slow down in 2008 and 2009, which is consistent with the attempt of Tesco to lower the gearing ratio and use a great amount of its earnings to finance its businesses. As investor, we do not need to worry about the future slowing down of increase of dividends may reflect some negative signs; instead many leading firms like Tesco endeavor to use a stable and smooth dividend policy, because of the increasing risks of long-term debt .