Louisiana State University LSU Digital Commons LSU Historical Dissertations and Theses Graduate School 1968 Earnings, Cash Flow, Dividend Payout and Growth Influences on the Price of Common Stocks. William Frank Tolbert Louisiana State University and Agricultural & Mechanical College Follow this and additional works at: https://digitalcommons.lsu.edu/gradschool_disstheses Recommended Citation Tolbert, William Frank, "Earnings, Cash Flow, Dividend Payout and Growth Influences on the Price of Common Stocks." (1968). LSU Historical Dissertations and Theses. 1522. https://digitalcommons.lsu.edu/gradschool_disstheses/1522 This Dissertation is brought to you for free and open access by the Graduate School at LSU Digital Commons. It has been accepted for inclusion in LSU Historical Dissertations and Theses by an authorized administrator of LSU Digital Commons. For more information, please contact [email protected]. This dissertation has been microfilmed exactly as received 69-4505 TOLBERT, William Frank, 1918- EARNINGS, CASH FLOW, DIVIDEND PAYOUT AND GROWTH INFLUENCES ON THE PRICE OF COMMON STOCKS. Louisiana State University and Agricultural and Mechanical College, Ph.D., 1968 Economics, finance University Microfilms, Inc., Ann Arbor, Michigan William Frank Tolbert 1969 © _____________________________ ALL RIGHTS RESERVED EARNINGS, CASH FLOW, DIVIDEND PAYOUT AND GROWTH INFLUENCES ON THE PRICE OF COMMON STOCKS A Dissertation Submitted to the Graduate Faculty of the Louisiana State University and Agricultural and Mechanical College in partial fulfillment of the requirements for the degree of Doctor of Philosophy in The Department of Business Finance and Statistics b y . William F.' Tolbert B.S., University of Oklahoma, 1949 M.B.A., University of Oklahoma, 1950 August, 1968 ACKNOWLEDGEMENT The writer wishes to express his sincere apprecia­ tion to Dr. Donald E. Vaughn, Associate Professor of Finance and Chairman of the dissertation committee for his valuable assistance, guidance, and suggestions rendered in the preparation of this thesis. 1 am, also, deeply indebted to Dr. Don L. Woodland, Associate Professor of Finance and to Dr. William E. Swyers, Associate Professor of Accounting who were most helpful with the preparation of this manuscript. And to Dr. Stanley Preston, Professor of Finance, and Dr. Leon C. Megginson, Professor of Management, goes the special gratitude for the writer's introduction and training in analyzing and development of many new con­ ceptual relationships. Finally, my appreciation is offered to my wife for her patience and perseverance as my typist and for her gracious forbearance of many holidays which were ?devoted to dissertation." ii TABLE OF CONTENTS CHAPTER Page ACKNOWLEDGMENT........................ ii LIST OF TABLES ...................... vi ABSTRACT .............................. vii I. INTRODUCTION ........................ 1 Importance and Purpose Of The Study. 4 Definitions of Terminology . w . 6 Scope and Limitations Of The Study . 10 Sources of D a t a .................. 11 Organizational P l a n .............. 12 II. REVIEW OF THE LITERATURE ............ 14 Literature On Earnings and Growth Influences On Common Stock Prices. 14 Literature On Cash Flow Influences On Common Stock Prices .......... 32 Literature On Dividend Payout Influences On Common Stock Prices. 39 Summary and Conclusions .......... 45 III. ALTERNATIVE ACCOUNTING POLICIES AVAILABLE FOR DETERMINATION OF EARNINGS .......................... 48 R e v e n u e .......................... 49 Cost of Goods S o l d ................ 50 Depreciation, Amortization, and Depletion .................. 53 Cash F l o w ........................ 55 Expensing Versus Capitalizing . 57 Replacement of Assets ............ 59 Non-operating Income and Expenses . 61 Contingency "Reserves" ....... 64 Subsidiaries and Affiliates .... 68 M e r g e r s .......................... 70 Income Tax Reconciliation ..... 72 Summary and Conclusions ........ 73 iii CHAPTER Page IV. DETERMINATION OF DIVIDEND POLICIES . 75 Kinds of Dividend Policies..... 77 Determinants of Dividend Policies . 78 Types of Dividends............. 82 Primary Distinction Between Stock Dividends and Stock Split-Ups. 84 Accounting by the Issuer ....... 87 Accounting by the Stockholder . 88 Summary and Conclusions .......... 89 V. STUDY OF EARNINGS, CASH FLOW AND COMMON STOCK PRICE MOVEMENTS .... 91 The Sample ....... .......... 91 Method of S t u d y ............... 93 The Earnings Hypothesis .......... 100 Presentation of Tables and Review and Discussion of D a t a ........ 101 The Cash Flow Hypothesis........ 105 Presentation of Tables and Review and Discussion of D a t a ........ 107 Summary and Conclusions .......... 110 VI. STUDY OF DIVIDENDS AND COMMON STOCK PRICE MOVEMENTS.................. 113 The Dividend Hypothesis .......... 113 Presentation of Tables and Review and Discussion of D a t a ........ 114 Prices of Stock Influenced by More Than One Independent Variable . 118 Summary and Conclusions .......... 124 VII. STUDY OF GROWTH AND COMMON STOCK PRICE MOVEMENTS.................. 125 The Growth Hypothesis ............ 125 Presentation of Table and Review and Discussion of D a t a ........ 126 Summary and Conclusions .......... 127 VIII. SUMMARY AND CONCLUSIONS............ 130 S u m m a r y ........................ 130 Conclusions .................... 132 Recommendations .................. 134 iv CHAPTER Page SELECTED BIBLIOGRAPHY ................ 135 APPENDICES ............................ 140 VITA .................................. 215 v LIST OF TABLES ,TABLE Page I. Regression of Price On Earnings .... 104 II. Regression of Price On Earnings 2 . 106 III. Regression of Price on Cash Flow And Cash F l o w ^ .......................... 109 IV. Regression of Price on Dividends . 116 2 V. Regression of Price on Dividends . 117 VI. Equations for Price Involving More Than One Variable.................... 119 VII. Equations for Price Involving More Than One Variable (Lagged Method) . 123 VIII. CompaniesWith Earnings Growth Equal To Or Greater Than Twelve Percent . 12 8 ABSTRACT The purpose of this study is to test empirically the validity of the three important theories purporting to explain what is purchased when a share of stock is bought by an investor, and to attempt to answer the question concerning the variable which exerts the most influence on an investor in his stock selection. The theories tested are that an investor pays for: 1. the earnings, 2. the dividends, and 3. growth. Cash flow, earnings, dividends, and prices were obtained for sixty leading industrial companies. These companies are not a statistical sample of all leading industrial companies, but their number is sufficiently large that their financial data are believed to be representative of the data for leading industrial companies. The companies chosen, also, provided considerable variation in such attributes as size, profitability, and structure of the markets in which they buy and sell. Cash flow was one of the variables studied because it was felt that conventional earnings might reflect the fact that enlightened managements' could utilize accounting vii alternatives which would not result in comparability of data between companies. Also, this variable was included in the hope that the analysis would disclose the effect of financial and accounting policies upon the other primary variables. The influence of the primary variables (i.e., earnings, cash flow, and dividends), as well as certain other con­ structed variables were examined by the employment of multiple regression analysis techniques. The program used includes a deletion phase for the automatic deletion of the least significant independent variable, and performs a new regression with the remaining independent variables. Automatic deletion and re-computation continues until the variable, if any, is disclosed which exerts the most influence on a particular common stock's price. This particular method of study substantiates that stock prices for some companies were influenced most of all by earnings or some variant of earnings. Some prices were seen to have a strong relationship with cash flow, others with dividends and still others with growth. It was not possible to determine that there was a direct effect of financial and accounting policies upon earnings per share. Indirectly it was noted that some stock prices did move with cash flow changes rather than with earnings. Likewise, only by indirect means could it be determined that "earnings" proved to be the dominant variable which viii influences an investor in his stock selection. This can be argued only if it is accepted that the other variables are merely derivatives of earnings, and that earnings must be achieved before it is possible to obtain cash flow and to be able to pay any dividend other than liquidating dividends. Since there are many influences which determine the movements of security prices, it is of importance to study all of the forces at work, and then make some sort of composite picture. Also, improvement might be achieved by expanding the model to include factors for growth and for other economic indicators which influence the valuation of growth expectations. CHAPTER I INTRODUCTION Some twenty million shareholders^- in the United States scan their daily papers and seek other sources of informa­ tion in an attempt to discover what changes have occurred in the prices of common stocks. Their fascination for the stock market is undergirded with the desire to validate their past purchases of