Question

Home Depot, Inc.’s income statements for 2013, 2014, and 2015 show basic earnings per share of $3.78, $4.74, and $5.49, respectively. Diluted earnings per share figures are slightly lower than these numbers, indicating the impact of potential capital stock activity that could reduce earnings per share for current stockholders. The company paid cash dividends of $1.56 per share in 2013, $1.88 per share in 2014, and $2.36 per share in 2015.

a. Why do you think Home Depot is paying out only about 40 percent of its net income to stockholders in the form of cash dividends?

b. If you were an investor in Home Depot’s stock, would you be unhappy because your dividends represented about 40% of the company’s net income?

Answer 1

SOLUTION:

EPS is one of the indicators of the profitability of a firm.It is calculated by diving net income with total no. of outstanding shares.

Facts of the case:

EPS of Home Depot, Inc.’s for 2013, 2014, and 2015 is given. Diluted earnings per share figures are slightly lower than EPS.

a) Home Depot is paying out only about 40 percent of its net income to stockholders in the form of cash dividends.

Possible Reasons:

Funding required for Growth

Dividends are given from company's retained earnings, which actuallyrepresents the total amount of profit accumulated over time that has not been previously distributed as dividends in prior years or otherwise used up.Instead of paying out a large portion of the corporation's annual profits as dividends, Company may decide not to pay dividends and to retain the earnings in the company and reinvest profits for future growth.

To Delay Dividends to Preference shareholders

To issue dividends to common shareholders, the company must first pay back any dividends due to preferred shareholders. In some cases, a company may have the funds necessary to pay a common dividend but not to pay both preferred and common dividends. In this case, a company may choose to pay preferred dividends but suspend common dividends or decide to suspend all dividends entirely.

Financial crunch

The main reason for lower dividend is the issuing company is under financial strain. Because dividends are issued to shareholders out of a company's retained earnings, a company that is struggling may choose to suspend dividend payments to safeguard its financial reserves for future expenses. If revenue is down or costs are up, the amount of money left over for dividends at the end of the year may be minimal or nonexistent.

Unexpected Expenses

Another reason a company may pay lower dividends is due to unexpected one-time expenses that temporarily reduce profits. Even if revenues remain constant year to year, a lawsuit judgment against the company or the need to replace or update costly equipment may require the company to use its earnings for other purposes.

Paying Debt

The board of directors may use extra profits to pay off corporate debt instead of paying a dividend to shareholders. Interest expense will be reduced if Company decides to pay off debt, which should result in higher profits -- from which to pay bigger dividends -- in the future.

b)

So as an investor I would perform the fundamental analysis of the company and I would not judge the Company by merely its dividend paying capacity.

If the Company has good plans for growth prospects in future, then thre is a high possibility that value of our investment would be higher.Also if it wants to pay off debt then also the cake of profit will be higher in coming years for equity shareholders.

However, if after doing the analysis, if it comes to notices by reading the financial statements that company has an unxpected huge expense like lawsuit then that would question the companies ability to survive.

Also, if lower dividends are stemming out from financial crunch, like lack of sales due to saturated market,tough competion,low quality products it is better off to sell the shares.