Payout Decisions

The decision to pay dividends or repurchase shares impacts stock prices due to the expectations and signals such decisions create. Therefore, these decisions need to be systematic and well-considered. The process can be divided into four stages:

1. Forecasting various scenarios of operational cash flows – What will cash flow forecasts look like in the case of intensified competition or an economic recession?
2. Determining the target capital (D/E) structure – If we rely on ratings, the debt level might be defined by Coverage & Leverage multiples. For example, the EBITDA-to-Debt Ratio.
3. Assessing cash deficits and surpluses – Based on the previous two stages, what deficit or surplus cash is generated in the cash flows?
4. Planning dividend or share repurchase decisions – The level of dividends is set for the worst-case scenario, while repurchases are considered in cases of surplus cash.

Excel File with formulas.

Source:

Valuation: Measuring and Managing the Value of Companies – by McKinsey & Co, T. Koller, M. Goedhart, D. Wessels