Case: DAVE STARTS LOOKING FOR YIELD
Dave Peterson is a commercial artist who makes a good living by doing freelance work-mostly layouts and illustrations for local advertising agencies and major institutional clients (such as large department stores). Dave has been investing in the sharemarket for some time, buying mostly high-quality growth shares. He has been seeking long-term growth and capital appreciation and feels that with the limited time he has to devote to his security holdings, high-quality issues are his best bet. He has become a bit perplexed lately with the market, disturbed that some of his growth shares aren't doing even as well as many good-grade value shares. He therefore decides to have a chat with his stockbroker, Alan Fried. During the course of their conversation, it becomes clear that both Alan and Dave are thinking along the same lines. Alan points out that dividend yields on value shares are indeed way up and that, because of the state of the economy, the outlook for growth shares isn't particularly bright. He suggests that Dave seriously consider putting some of his money into value shares to capture the high dividend yields that are available. After all, as Alan says, ‘The bottom line isn't so much where the payoff comes from as how much it amounts to!' They then talk about a high-yield public utility company, Hydro-Electric Light and Power. Alan digs up some forecast information about Hydro-Electric and presents it to Dave for his consideration:
|
Year
|
Expected EPS
|
Expected Dividend
Payout Ratio
|
|
2010
|
$3.25
|
40%
|
|
2011
|
3.40
|
40
|
|
2012
|
3.90
|
45
|
|
2013
|
4.40
|
45
|
|
2014
|
5.00
|
45
|
The company currently trades at $60 per share, and Alan thinks that within five years it should be trading at a level of $75-$80. Dave realises that in order to buy the Hydro-Electric shares, he will have to sell his holdings of CapCo Industries-a highly regarded growth company that Dave is disenchanted with because of recent substandard performance.
QUESTIONS:
1. How would you describe Dave's present investment program? How do you think it fits him and his investment objectives?
2. Consider the Hydro-Electric shares.
a. Determine the amount of annual dividends Hydro-Electric can be expected to pay over the years 2010-2014.
b. Calculate the total dollar return that Dave will make from Hydro-Electric if he invests $6000 in the shares and all the dividend and price expectations are realised.
c. If Dave participates in the company's dividend reinvestment plan, how many shares will he have by the end of 2014, and what will they be worth if the share trades at $80 on 31 December 2014? Assume that the share can be purchased through the dividend reinvestment plan at a net price of $50 a share in 2010, $55 in 2011, $60 in 2012, $65 in 2013 and $70 in 2014. Use fractional shares, to two decimals, in your calculations. Also, assume that Dave starts with 100 shares and all dividend expectations are realised.
3. Would Dave be going to a different investment strategy if he decided to buy shares in Hydro-Electric? If the switch is made, how would you describe his new investment program? What do you think of this new approach, and is it likely to lead to more trading on Dave's behalf? If so, can you reconcile that with the limited amount of time he has to devote to his portfolio?