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Lesson 2 of 9 · 13 min
Choosing the cash flow: dividends or FCFE
Dividends are the narrowest cash flow to equity and fit only steady, high-payout companies; FCFE adds buybacks, share issues and retained cash, so it fits most other companies but moves with every financing choice.
In short
- Present value models use one of four measures: dividends, FCFE, FCFF or residual income (RI). RI is an income measure, not a cash flow.
- Dividends fit companies with positive, stable earnings that pay out a large, consistent share and rarely change their share count, such as regulated utilities and REITs.
- A DDM values equity from the view of a non-controlling shareholder, who cannot change the payout policy.
- FCFE = Δcash + dividends + repurchases − share issuance. FCFE can be negative; dividends cannot.
- With a target debt ratio DR: FCFE = net income − (1 − DR) × net investment. Less investment or more debt financing raises FCFE.
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