The study of Florida Power and Light Company (FPL) is to determine if a company's value can be affected by the negative signals of dropping its dividend levels. Our recommendation is to buy FPL stock, even though its stock price fell 6% after the market analysis of its dividend cut prediction. It is true that dividends signal company's future value and market reacts inversely. But FPL was a special case because it was a healthy company that cut its dividend.
It is instinctive to consider FPL's business environment when it made the dividend announcement. The two reasons that lead FPL to cut its dividend were: the recent speed of deregulation in the utilities industry that forced FPL to start thinking about the impact of not being a regulated company, and the fact that the dividend payout had grown to a higher than normal level on a historical basis. The average EPS growth rate from 1984 to 1993 was only 0.9%, but the Dividends Per Share growth rate was 3.8%, which was much faster than the company's earnings. (See Exhibit 4b)
There are two theories about dividends usually used to explain the market response to the company's dividend policy. One is Signaling Hypothesis. This theory is based off the idea that managers have better information about a firm's future prospects than public stockholders do. Since future dividends are paid out of future profits, and given that managers are reluctant to cut dividends, any change in dividends to be paid is often viewed signal of future profits. Thus, increases in dividends generally result in stock price increases and cuts in dividends generally result in stock price declines. This is theory that most of the market analyst based on when they issue their opinions on FPL.
Comparing to the early 90's, FPL had taken $5.8 bill ...