Thursday, August 12, 2010

Stock vs Cash Dividend - The 3rd choice

Variable Dividends (or Fixed Yield Dividends) are a cash dividend that is equivalent choice to a fixed fractional stock dividend.  A fixed fractional stock dividend of 1/10th or 1/40th of a share has a variable cash dividend equivalent of 1/11th or 1/41th of the stock's market value.  The cash value of the dividend is variable with the stock price, which makes the dividend yield fixed.  So even if corporations don't pay as high a dividend as shareholders deserve, they can pay more when stock price is doing well, and less when it is doing poorly.  So can afford a higher target payout ratio, and smooth out stock price fluctuations by providing investors with a mechanism to hold low and sell high.

While all investors should be disappointed with management's primacy of self agendas over their contractual mandates, I recognize that there are far greater evils in this world.  Living with the reality of corruption of mandates to shareholder value,  and deceptions to investors regarding shareholder rights, the continued health and capitalization of the corporation does benefit other direct stakeholders (management, employees, customers).  Yet a higher target dividend payout is possible through variable dividends without compromising the health of the company.

A 3rd choice is possible to boost target payout rates much higher.  Issuing a loan option instead of or in addition to the cash dividend option provides a way for the company to issue high dividends without reducing corporate assets at all.  Issuing a loan, retains the same earnings power for the company.  The interest benefit is a shareholder benefit if the loan is issued as a dividend.

A queued soft loan is a superior alternative in every way to a bond loan for both investors and the honest fair-minded corporation.  Soft loans have a certain priority to payment that can not be worsened for investors, and so corporations can benefit from lower financing costs associated with providing a better valued security.

To boost payout the highest, a cash dividend choice need not be offered.  If the company is debt free, then a QSL vs stock dividend choice results in a virtually immediate cash payment to some of the loan dividend choosers.  the company can pay its earnings towards the new QSLs immediately.

To price the QSL dividend choice benefit, the principal amount is equal the cash dividend equivalent to the fixed fractional stock dividend (1/11th stock price if fractional stock dividend is 1/10th of a share).  The interest rate could be bid on, but that requires logistical support.  In healthy public companies, because QSLs guarantee no dilution of payment priority to the loan holder, every loan has an estimated organic (from operations) payment date.  Organic expected payment date can be used to set the Dividend replacing QSL interest rate to match the government bond rates of similar duration, adding a premium of, say, 20 basis points per expected year of repayment.

A high dividend choice not only allows a naturally efficient mechanism to separate shareholders into those that want to determine purpose of the enterprise vs. those that simply want financial benefit from the enterprise, but it also helps expedite purpose-aspirational shareholders to takeover the company without paying market premiums for it, but in a fair way to all other shareholders.  By bidding on dividend increase projects through QSLs, purpose aspirational shareholders encourage the corporation to boost dividend payout even more, and provide the benefit aspirational dividend choosers with cash payments.

A typical target dividend payout ratio for mature healthy public corporations (that pay dividends) is typically 50% of earnings.  It is 75%+ for Canadian Income Trusts.  When Income Trusts have poor performance periods where there payout reaches 100% of income, their market capitalization tends to drop below their book value, and yields go higher than P/Es.  The market is scared of high payout ratios, mostly because of fear that fixed dividends will be reduced rather than the fear that bankruptcy becomes imminent.  A variable dividend can allow the income trust to pay according to target earnings, and can payout 90%-100% of those earnings targets, because when it falls behind, it will naturally drop in stock price, and pay out less.  Their dividends become self adjusting.

Because of the obvious appeal of high dividend corporations, and the announced intentions of industrial icons (Bell Canada) to convert to Income Trust structure, the Canadian Government has effectively banned income trusts starting in 2011.  Variable dividends will allow converted Income trusts and  those corporations that wanted to be income trusts to boost payouts within management agendas.

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