Fundamentals of Financial Management (Concise 6th Edition)

452 Part 5 Capital Structure and Dividend Policy

so even when earnings were insuf! cient to cover the dividend, cash " ows took

up the slack and enabled the company to maintain a stable dividend policy.

Now look at Panel B. Here we see that the earnings payout is extremely vola-

tile, but the cash " ow payout (de! ned as DPS/CFPS) is relatively stable and always

well below 100%. Those stable (and high) cash " ows indicate that Chevron’s divi-

dend is relatively safe, and investors can count on receiving it going forward.

Indeed, given the very high cash " ows per share, continued substantial dividend

increases (or large share repurchases) are likely—provided something bad doesn’t

happen in the oil market.

Chevron is typical of most large, strong companies. Its dividend is depend-

able, and it grows at a steady rate. Earnings are relatively volatile; but cash " ows

are more stable, and those stable cash " ows are responsible for the steady divi-

dends. When earnings change dramatically, either up or down, dividends are

likely to follow with a lag while management determines whether the earnings

Panel A

$0

198519871989199119931995199719992001200320052007

198519871989199119931995199719992001200320052007

Above 100%, paying

out more than earned:

Bad, the higher the

payout the riskier

the dividend.

DPS

EPS

CFPS

$2

$4

$6

$8

$10

$12

$14

Panel B

Payout

Earnings Payout versus Cash Flow Payout

Below 100%, earning

enough to pay the

dividend: Good, the

lower the payout the

safer the dividend.

0

100%

200%

Oil Prices Rose

Oil Prices Fell

Earnings Payout

Cash Flow Payout

Note: For consistency, data have been adjusted for two-for-one splits in 1994 and 2004.

Source: Adapted from Value Line Investment Survey, various issues.

Chevron: Cash Flows, Earnings, and Dividends, 1985–2007

F I G U R E 1 4! 1