An analysis based on what we have learnt during our SMU Financial Management Class. Particularly reviewing the Capital Asset Pricing Model (CAPM) and the Gordon Growth Model for Dividend pricing.
2. Dividend Strategy
Aramco introduced a mechanism for performance-linked dividends to support its aim to deliver a balanced mix of growth and yield to shareholders.
It is intended to be paid in the amount of 50-70% of the Group's annual free cash flow, net of the base dividend and other amounts including external investments.
The first performance-linked dividends were calculated based on the Group’s combined full-year results of 2022 and 2023 and are intended to be paid over six quarters.
There is a substantial increase in the total dividends paid from 2022 to 2023. However, we understand that there is a decrease in revenue by the company.
Having learnt that cash reinvested into the company would lead to better growth and long-term potential, would this adversely impact the stock price?
We see that there is an increase in outstanding shares as per the previous year. As a result, this should lead to a share dilution. However, we observe that the stock price has increased.
This would mean that there is an expected increase in growth rate be it in capital or dividends in order to sustain this.
Is this expectation realistic? We compare it to the CAPM model to see if there is another viewpoint. The data used for analysis will be the extracted Yahoo finance daily stock price data.
Assumptions made:
Covariance and Variance calculated using stock price fluctuations per trading day.
Adjusted trading days for Saudi market and SPY market.
S&P yearly growth rate = number of trading days * expected average return
Comparison between CAPM and GGM
Comparing both models, Gordon Growth Model should be used for stock analysis regarding Saudi Aramco. Some other conclusions made:
1. Plowing earnings back into new investments only makes sense if reinvested earnings earn a higher Rate of Return.
2. Individual stocks do not perform well in the market especially when adjusted for risk. Saudi Arabia main shareholder (82.2%).
3. Residual Dividend policy by Saudi Aramco (Non-constant % of earnings per year).
4. Saudi Arabia is Saudi Aramco's largest shareholder and they might have influence in the dividend policy of the company
In addition, Saudi Aramco has been reinvesting its cash flow in increasing its production capacity in previous years as a result of competition from renewables.
However, earlier this year, 2024, they have halted expansion projects. This could mean that they are confident in their competitiveness and are able to maintain supernormal profits for the foreseeable future.
