Dividends and Dividend Swaps

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					US Portfolio Strategy Turning cash into value

Dividend Focus

" The Goldman Sachs Group, Inc.
September 25, 2006

Dividends and dividend swaps. S&P 500 dividends/share should rise 11% to $24.69 in 2006, 7% to $26.52 in 2007 and 8% annually through 2015. Dividend swaps allow investors to trade dividend views. (1) Buy 2008 dividend swap for 7% potential upside. (2) Buy 2015, sell 2010 contracts to reflect optimistic growth outlook.

See the Disclosure section of this document for important disclosures about transactions in which The Goldman Sachs Group, Inc. or an affiliate is acting as financial advisor.

We expect dividend growth to exceed earnings growth beginning in 2009 Dividend growth increased following the 2003 change in tax rate supported by strong underlying earnings growth. Dividends grew 11%/year from 2002 to 2005. Growth will likely slow to 8%/year but remain above trend earnings growth (7%/year) as the payout ratio rises. Long-term dividends are driven by capacity to pay and propensity to pay The capacity to pay is determined by earnings growth and cash levels. The propensity to pay is a company-specific decision that is influenced by factors including federal tax policy. Trade #1: Buy the 2008 dividend swap contract for 7% expected return Our scenario analysis suggests downside risks are minimal. The implied level is below the worst-case scenario. There are limited trading opportunities for 2006-2007 index dividends. Trade #2: Buy the 2015 dividend swap and sell the 2010 contract The dividend term structure implies the compound annual growth rate declines after 2010. The market-implied 5-year compound annual dividend growth rate of 4.1% per year for 20102015 is below our 8.5% estimate.
There is upside to dividend swap contracts beginning in 2008
$65 Dividends ($/share) $60 $55 $50 $45 $40 $35 $30 $25 $20 2005 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E $22.22 $24.69 $26.52 $31.43 $28.72 $39.83 $33.84 $36.72 Market-implied dividend level Goldman Sachs estimate $50.77 $43.20 $46.84 $55.01

Source: Goldman Sachs.

The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Analysts employed by non-US affiliates are not required to take the NASD/NYSE analyst exam.
Global Investment Research

Customers of The Goldman Sachs Group, Inc. in the United States can receive independent, thirdparty research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at http://www.independentresearch.gs.com or can call 1-866-727-7000 to request a copy of this research. For Reg AC certification, see page 30. For other important disclosures, see page 33, go to http://www.gs.com/research/hedge.html, or contact your investment representative.

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Table of contents
1 Dividends and dividend swaps 2 Dividends should grow faster than earnings beginning in 2009 3 Swaps offer a way to trade the level and growth of dividends 4 Returning cash to shareholders will likely remain a priority 5 Capacity and propensity to pay drive dividend growth 6 Companies have a high capacity to pay dividends 8 The propensity to pay has not increased as much as expected 12 Buying opportunities exist in longer-term dividend swaps 19 2006-09 scenario analysis: Considering all dividend estimates 23 Appendix A: Introduction to index dividend swaps 25 Introduction to index dividend swaps 33 Disclosures

The prices in this report are based on the market close of September 21, 2006.

Goldman Sachs Global Investment Research - September 25, 2006

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Portfolio Strategy

Dividends and dividend swaps
Dividends should grow faster than earnings starting in 2009
We estimate that S&P 500 dividends will increase 11% to $24.69 per share in 2006 and by 7% to $26.52 per share in 2007. Dividends grew at an 11% compound annual

growth rate from 2002 to 2005. The recent trend represents a major increase over the prior ten years when dividends only grew at a 2% annual pace.
We expect dividends will grow at a 8% annual rate from 2009 through 2015. Our long-term estimates are in-line with what our bottom-up estimates for both dividends and earnings for the next four years. The 8.5% dividend growth rate reflects S&P 500 trend earnings growth of 6.7% beginning in 2009, and a 50 basis point increase in the dividend payout ratio each year until the payout ratio equals 32.5%.

Two drivers of long-term dividends: capacity to pay and propensity to pay
The capacity to pay is determined mainly by macroeconomic factors (real GDP and

earnings growth) but may be influenced by microeconomic factors that affect cash deployment such as current cash levels and working capital management.
The propensity to pay is more a company-specific decision that may be influenced by

factors including federal tax policy and investor demand. Alternative uses of cash include share repurchases and investing via capital expenditures or cash acquisitions.

Swaps offer a way to trade both the level and growth rate of dividends
S&P 500 dividend swaps enable investors to trade index dividend performance separately from price performance. An index dividend swap is a contract that enables

investors to take a view on the future dividends to be paid on a stock index relative to the prevailing level implied by the market. For the S&P 500, dividends can be traded far into the future, enabling investors to trade views on long-term dividend growth.
Trade Idea #1: Investors should buy 2008 dividend swap contract. Our scenario analysis suggests downside risks are minimal. There are limited trading opportunities for 2006-2007 index dividends. 2006-2007 market-implied dividend levels are in line with our bottom-up forecasts. Trade Idea #2: Buy the 2015 dividend swap and sell the 2010 contract. The dividend

term structure implies that the compound annual growth rate declines after 2010. The market-implied 5-year compound annual dividend growth rate of 4.1% per year for 20102015 is below our 8.5% estimate. Investors may implement this view with a steepening trade (sell a near-dated contract and buy a long-dated contract). We estimate 2006-2009 dividends on a bottom-up basis using Goldman Sachs estimates when available, and consensus estimates when they are not. After 2009, we use a topdown model to forecast dividend growth. A bottom-up perspective is appropriate for estimating near-term dividend levels. However, beyond four years the risks outweigh the benefits of using this model.

Goldman Sachs Global Investment Research - September 25, 2006

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Dividends should grow faster than earnings beginning in 2009
We estimate that dividends will increase 11% to $24.69 per share in 2006 and a further 7% to $26.52 per share in 2007 (See Exhibit 1). Dividend growth increased substantially following the 2003 change in tax rate supported by strong underlying earnings growth and cash flow beginning in 2004.

Dividends grew at an 11% compound annual growth rate from 2002 to 2005. This is a major increase over the prior ten years, when dividends only grew at 2% annually.
We expect dividends will grow at an annual rate of approximately 8% from 2009 through 2015. Our long-term top-down estimates are in line with what our bottom-up

estimates for both dividends and earnings over the next four years. The 8.5% growth rate reflects S&P 500 trend earnings growth of 6.7% beginning in 2009, and a 50 basis point annual increase in the dividend payout ratio from 29.5% in 2009 to 32.5% in 2015. The payout ratio is currently 30.2%.
Exhibit 1: We expect S&P 500 dividends per share will rise 11% in 2006 to $24.69 and grow at 8% from 2009-2016

$60 Dividends ($/share) $50 $40 $30 $20 $10 $0 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E
12.38 12.58 15.49 16.20 16.69 16.27 15.74 16.07 13.18 13.79 14.90 17.38 19.44 22.22 24.69 26.52 28.72 31.43 33.84 36.72 39.83 43.20 46.84

55.01 50.77

2015E
8%

16% 14% 12% 10% 8% 6% 4% 2% 0% (2%) (4%) (6%)

Dividends (yoy % change)

14% 12% 11% 8% 4% 5% 3% 2% 8% 8% 7% 9% 8% 9% 8% 8% 8% 8%

(3%) (3%)

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006E

2007E

2008E

2009E

2010E

2011E

2012E

2013E

2014E

2015E

Note: Dividends per share is estimated on a bottom-up basis through 2009. After that, we assume S&P 500 trend earnings growth of 6.7% and a 50 basis point annual increase in the dividend payout ratio each year until the payout ratio equals 32.5% in 2016. Dividends/share excludes special dividends

Source: Compustat and Goldman Sachs Research estimates.

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Goldman Sachs Global Investment Research - September 25, 2006

2016E

2016E

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

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Portfolio Strategy

Swaps offer a way to trade the level and growth of dividends
Investors should buy the 2008 dividend swap contract for 7% upside. 2006-2007

market-implied dividend levels are in line with our bottom-up forecasts.
Exhibit 2: Currently, bottom-up forecasts suggest much more upside in longer-dated dividend swaps market implied levels as of September 25, 2006
70.00 65.00 60.00 Dividends ($/share) 55.00 50.00 45.00 40.00 35.00 30.00 25.00 20.00 Worst-case

Goldman Sachs estimates Implied Dividend Swap Level
Best-case

Best-case Scenario Goldman Sachs estimates Worst Case Scenario Implied Dividend Swap Level Upside / (Downside)(%) to Best Case Scenario to Goldman Sachs to Worst Case Scenario

2006 $25.10 24.69 24.23 24.58 2.1 0.5 (1.4)

2007 $27.91 26.52 25.43 26.67 4.7 (0.6) (4.6)

2008 $30.99 28.72 27.15 26.89 15.2 6.8 1.0

2009 $32.33 31.43 29.96 30.31 6.7 3.7 (1.1)

2010 $35.57 33.84 31.97 31.46 13.0 7.5 1.6

2011 $39.24 36.72 34.11 32.09 22.3 14.4 6.3

2012 $43.24 39.83 36.39 33.78 28.0 17.9 7.7

2013 $47.60 43.20 38.83 36.37 30.9 18.8 6.8

2014 $52.36 46.84 41.43 38.17 37.2 22.7 8.6

2015 $57.53 50.77 44.21 38.43 49.7 32.1 15.0

2016 $63.16 55.01 47.17 44.17 43.0 24.5 6.8

Source: I/B/E/S, Goldman Sachs Research estimates.

Buy the 2015 dividend swap and sell the 2010 contract. The dividend term structure

implies the compound annual growth rates declines after 2010. The market-implied 5year compound annual dividend growth rate of 4.1% per year for 2010- 2015 is below our 8.5% estimate. One risk is that the steepening occurs after the 2010 contract settles.
Exhibit 3: Currently, long-term growth is being priced at a discount market-implied levels as of September 25, 2006
12.0% Annualized 5-yr growth (%) Best-case 10.0% 8.0% 6.0% Worst-case 4.0% 2.0% 0.0%

Goldman Sachs estimates Implied Dividend Swap Level 20062011 8.8% 8.8 8.1 5.5 20072012 9.2% 8.4 7.8 4.8 20082013 9.6% 8.5 7.5 6.2 20092014 9.8% 8.6 7.0 4.7 20102015 10.1% 8.5 6.7 4.1 20112016 10.0% 8.5 6.7 6.6

Best-case Scenario Goldman Sachs estimates Worst Case Scenario Implied Dividend Swap Level

Source: Goldman Sachs.

Goldman Sachs Global Investment Research - September 25, 2006

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Returning cash to shareholders will likely remain a priority
Firms are likely to have wide flexibility to deploy cash given strong balance sheets and cash flow. We expect S&P 500 firms will generate approximately $1.1 trillion

dollars in operating cash flow in 2006 and will wind down cash balances by $150 billion. Last year, for the first time ever, companies returned slightly more cash to shareholders (via buybacks and dividends) than they used to fund growth (capex and M&A). We believe this trend will continue in 2006, as companies return 51% of cash to investors and use 49% for growth:
Exhibit 4: How companies are likely to spend $1.25 trillion in 2006

2006 USE OF CASH
Invest for Growth Cap-Ex
$450 bn (36% of total)

Return to Shareholders Dividends
$220 bn (18%)

Acquisitions
$165 bn (13%)

Buybacks
$410 bn (33%)

Source: Compustat and Goldman Sachs Research estimates.

Companies will likely re-invest in their business 49% of total cash spent. Capital expenditures should account for 36% of spending. We estimate that cap-ex will increase 9% to $450 billion in 2006. Cash M&A should be 13% of spending; total M&A volume may reach $1.6 trillion. We estimate that cash M&A will increase 9% to $165 billion in 2006. Companies will likely return to shareholders 51% of total cash spent. Dividends

should be 18% of spending. We estimate that dividends will increase 9% to $220 billion in 2006. Buybacks should account for 33% of spending. We estimate that cash spent on buybacks will increase 12% to $410 billion in 2006. Buyback announcements year-todate already equal the record set in 2005.
Exhibit 5: Companies will likely increase spending in 2006 AND return more cash to investors than invest for growth
1400 1200 1000 800 600 400 200 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005E 2006E Operating Cash Flow Buybacks Dividends Cash acquisitions Capital Expenditures

Use of cash: Invest for Growth
(cap-ex+M&A)

Cash Sources/Uses ($ billions)

64% 36%

60% 40%

63% 37%

63% 37%

65% 35%

67% 33%

61% 39%

58% 42%

51% 49%

50% 50%

49% 51%

Return to Investors
(buybacks+dividends)

Source: Compustat and Goldman Sachs Research estimates.

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Goldman Sachs Global Investment Research - September 25, 2006

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Portfolio Strategy

Capacity and propensity to pay drive dividend growth
We expect dividends will grow at an annual rate of approximately 8% from 2009 through 2015. The 8.5% growth rate reflects S&P 500 trend earnings growth of 6.7%

beginning in 2009, and a 50 basis point annual increase in the dividend payout ratio from 29.5% in 2009 until it reaches 32.5% in 2015. We expect the payout ratio will start to increase after a 60-year decline, driving above average long-term dividend growth (See Exhibit 6).
Dividend growth is dependent on two main factors: the capacity to pay and the propensity to pay. The capacity to pay is determined mainly by macroeconomic

factors (real GDP and earnings growth) but may be influenced by microeconomic factors that affect cash deployment such as current cash levels and working capital management. The propensity to pay, however, is more a company-specific decision that may be influenced by factors including federal tax policy and investor demand.
Dividend growth has historically been positively correlated with earnings growth. Dividend growth has tended to slightly lag improving fundamentals, as management

wants to “make sure” that the growth is not transitory. The correlation of 5-year compound growth rates is much higher than the correlation of the 1-year growth rates (0.73 vs. 0.56). The correlation of 5-year growth rates increases slightly to 0.75 when earnings growth is lagged by one period.
While companies often wait to raise dividends, they are also loath to cut them. As a result, dividend growth tends to be much less volatile than earnings growth. The

volatility of annual earnings growth has been 14.5% since 1943, while the volatility of annual dividend growth has only been 5.7%.
Exhibit 6:
30 25
Annualized 5-yr growth

Dividend growth should exceed earnings growth beginning in 2009 as earnings grow at trend rates.
Forecast

20 15 10 5 0 (5) (10) 1943 1946 1949 1952

Average Median Volatility

Earnings Growth 1-yr 5-yr CAGR 8.0 6.7 9.7 6.8 14.5 5.6

Dividend Growth 1-yr 5-yr CAGR 6.1 5.6 5.1 5.1 5.7 3.4

Dividends Earnings

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015

Notes: Historical operating EPS growth is based on a Goldman Sachs proprietary series. Through 1986, we use reported EPS. Since then, we use operating EPS. Volatility is measured by the standard deviation of growth rates. Shaded bars indicate US recession, as defined by the NBER.

Source: Standard & Poor’s, Compustat and Goldman Sachs Research estimates.

Goldman Sachs Global Investment Research - September 25, 2006

2018
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Companies have a high capacity to pay dividends
Strong sustained earnings growth should enable companies to increase their regular dividends going forward. On a bottom-up basis, S&P 500 earnings growth is

expected to be 15% in 2006, 10% in 2007, and 9% in 2008. We expect growth to average 7% from 2009-2015, in line with the trend rate measured from 1943 to 2005. Earnings growth has been above the long-term average for the past 17 consecutive quarters. Bottom-up estimates imply double-digit earnings growth will persist into 2007, based on consensus estimates for the S&P 500 (see Exhibit 7). Long-term S&P 500 earnings growth can often exceed nominal GDP growth due to its survivorship bias. Bankrupt or low-quality companies are often replaced with fastergrowing substitutes.
Energy and Materials companies are good examples of those that have had the capacity to pay dividends, but have not shown a propensity to pay so far this cycle.

Earnings growth over the past three years has been particularly strong in these two sectors, but many of these companies have elected not to increase their dividends as quickly as earnings were growing. Instead, many companies paid out special dividends (See Exhibit 30 for a list of special dividends paid out so far in 2006). As these companies’ profit growth slows to a more sustainable pace, they will likely increase their payout ratios.
Exhibit 7: There have been 17 consecutive quarters with above-trend growth

50 45 40 35 30 25 20 15 10 5 0

S&P 500 500 EPS growth
3Q2006 is expected to be the 18th consecutive quarter w ith above-trend grow th. This should persist into 2007.

EPS Growth (YoY)

Trend gro wth=7%

2Q02

4Q02

2Q03

4Q03

2Q04

4Q04

2Q05

4Q05

2Q06

4Q06E

2Q07E

Materials Financials Energy Telecommunication Services S&P 500 Utilities Industrials Consumer Discretionary Consumer Staples Information Technology Health Care

2006E Earnings Growth 1Q 2QE 3QE 4QE 10 % 24 % 46 % 40 % 8 20 31 30 41 45 19 2 50 39 19 8 16 % 19 % 16 % 14 % 10 15 12 5 11 19 12 17 6 15 10 12 8 7 9 9 5 17 12 9 3 10 10 4

2007E Earnings Growth 1QE 2QE 3QE 4QE 12 % 0% (0)% (3)% 8 4 11 11 19 5 13 13 8 4 8 8 11 % 8% 13 % 13 % 8 18 13 12 10 16 16 14 9 6 15 13 12 11 13 12 11 19 20 19 5 6 17 16

4Q07E
Annual 2006E 2007E 28 % 3% 19 8 22 3 14 6 15 % 10 % 8 13 15 13 14 15 6 11 10 17 7 11

Note: Historical operating EPS growth is based on a Goldman Sachs proprietary series. Forward-looking growth is based on bottom-up consensus estimates.

Source: First Call, Compustat, and Goldman Sachs Research estimates.

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Goldman Sachs Global Investment Research - September 25, 2006

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Portfolio Strategy

Companies within the S&P 500 also have additional capacity to increase dividends through existing cash on the balance sheet. Companies in the S&P 500 had $2.6

trillion of cash and equivalents on their balance sheets as of August 31. The total was $782 billion excluding Financials. The cash-to-asset ratio for the S&P 500 excluding Financials currently stands at 9%, the highest level in 30 years. The cash-to-asset ratio has averaged 6% over the last thirty years and 6.6% over the last 10 years. If the cash-to-asset ratio reverted to its long-term average it would represent $206 billion of incremental spending. This “surplus cash” will not increase the amount of regular dividends paid, but having a strong balance sheet could provide companies with more flexibility to pay dividends out of earnings. Dividends paid to reduce cash balances would likely take the flavor of special dividends, similar to Microsoft’s $32 billion payment in November, 2004. If special dividends are small and become recurring, they are considered to be “regular” by Standard & Poor’s.
Exhibit 8: The cash/asset ratio for the S&P 500 is the highest in 30 years

10 9 Cash/Assets (%) 8 7 6 5 4 3 Dec-73 Dec-75 Dec-77 Dec-79 Dec-81 Dec-83 Dec-85 Dec-87 Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 30-yr average 6% Current 9%

Cash Balance Sector Information Technology Health Care Consumer Discretionary Energy Industrials Consumer Staples Materials Telecommunication Services Utilities S&P 500 ex-Financials Current $ 242 bn 142 121 74 105 48 20 15 16 $ 782 bn Current 26.1% 16.0 6.3 7.8 6.8 5.8 5.7 2.6 2.1 8.9

Cash / Assets Spending necessary Average Current less for cash/assets to (10 yr) 10-yr average revert to average 21.1% 501 bp $ 46 bn 11.9 413 37 5.8 44 8 4.5 328 31 3.6 318 49 4.4 138 11 3.7 199 7 3.1 (46) (3) 2.5 (41) (3) 6.6 235 $ 206 bn

Current Dividend Yield 0.7% 1.6 1.2 1.7 2.1 2.2 2.2 3.4 3.4 1.9

Source: Compustat and Goldman Sachs Research.

Goldman Sachs Global Investment Research - September 25, 2006

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The propensity to pay has not increased as much as expected
We use the dividend payout ratio (dividends per share / earnings per share) to gauge a company’s propensity to pay dividends. Shareholder-friendly actions took the spotlight in 2003 following the change in tax rate. Corporate managements also seemed to be under pressure to please investors

following several corporate scandals (e.g., WorldCom and Enron). While companies have increased the amount of dividends paid out by 11% per year since 2002, dividend growth did not kept pace with earnings growth, which rose 21% per year over the same period. This has resulted in a declining aggregate dividend payout ratio since the tax cut in 2003.
If the S&P 500 payout ratio continued to fall at the historical rate, there would be no dividends by 2060. The payout ratio has decreased 45 basis points on average each year

for the past 65 years, starting at over 80% in 1938 and dropping to a low of 30% in recent years. The dividend payout ratio of the S&P 500 averaged about 40% for almost two decades (1974-1994) before falling sharply during the technology bubble to a low of 30% in 2000. The blip up in the payout ratio in 2002 resulted from a sharp drop in earnings.
Exhibit 9:
90 80 Payout ratio (%) 70 60 50 40 30 y = -0.44x + 81 20 1938 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 2025

The S&P 500 payout ratio has decreased on average 45 basis points each year for the past 65 years

Notes: The payout ratio is defined as the dividends paid over a four-quarter period divided by the earnings over that same period. Historical operating EPS growth is based on a Goldman Sachs proprietary series which tends to be more conservative than other estimates. This results in a higher payout ratio in certain periods. Shaded bars indicate US recession, as defined by the NBER.

Source: Standard & Poor’s, Compustat and Goldman Sachs Research.

Currently, 385 companies in the S&P 500 pay a regular dividend. The aggregate

payout ratio depends on the constituent’s payout ratios and free float adjusted market caps. Since the constituents are market-cap weighted, the largest stocks have the greatest influence on the overall payout ratio.
There is huge variation between the 10 sectors of the S&P 500. Currently, average

payout ratios range from 13% (Information Technology) to 50% (Telecom Services and Utilities). Additionally, larger companies tend to pay out a larger percentage of earnings. The top quintile (largest 100 stocks) has a median payout ratio of 27%, 10 percentage points higher than the bottom quintile (smallest 100 stocks), which pay out only 17% of earnings.

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Portfolio Strategy

Baby-boomers and the dividend tax cut of 2003
Tax legislation enacted in 2003 reduced the tax rate on dividends to 15% from 38.6% and the capital gains tax to 15% from 20% for taxpayers in the highest bracket. This is the lowest rate at which dividends have been taxed since 1938, and marks only the second time that they were not tax disadvantaged vs. capital gains.
Exhibit 10: Long-term capital gains are no longer tax advantaged vs. dividends 2002-2006E
100 90 80 Tax Rate (%) 70 60 50 40 30 20 10 0 1938 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986

Dividend Tax Rate

Long-Term Capital Gains Tax Rate 1989 1992 1995 1998 2001
2001

Source: Internal Revenue Service and Goldman Sachs Research.

Much has been said about the dividend yield in the United States being at relative low levels compared with history. However, on an after-tax basis, which is the return that investors actually receive, the yield is actually higher than it has been over much of the last 60 years. Currently, the actual dividend yield is in the 13th percentile of dividend yields paid since 1938. But on a tax-adjusted basis, the current yield ranks in the 80th percentile.
Exhibit 11: On an after-tax basis, the dividend yield is above the historical average 1990-2006E
9.0 8.0 7.0 Dividend Yield (%) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1938 1941 1944 1947 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 Effective Dividend Yield (tax-adjusted) 1983 1986 1989 1992 1995 1998 2004 Actual Dividend Yield

Note: Dividend yield is calculated as the annual dividends paid divided by the Dec 31 closing price of the S&P 500.

Source: Internal Revenue Service, Standard & Poor’s, Compustat and Goldman Sachs Research.

Goldman Sachs Global Investment Research - September 25, 2006

2004

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The future of the dividend tax. The dividend tax break was originally set to expire at

the end of 2008, after which the tax rate would revert to the prior rate, which was the marginal tax rate. On May 17, 2006 the tax cut was extended for an additional two years, until the end of 2010.
Whether the dividend tax reduction is extended past 2010 is dependent on two main issues: (1) The balance of power in the Senate. Republicans would have a hard time

extending tax cuts if the number of Democrats in the Senate increases over the course of the next two elections (in 2006 and 2008). The vote on the extension this year was extremely close, despite Republicans holding a majority of seats.
(2) The state of the federal budget deficit. There may be tax reform passed sometime

before 2010. If passed, it would make it easier to extend the dividend tax cut. Any policy regarding an extension would likely come up for consideration in mid-2009 or early-2010. We do not expect any changes to the current dividend tax rate until then.
We believe the odds are in favor of the dividend tax cuts being extended. Currently,

the dividend tax is considered a “rich-person’s tax”. However, as we near the end of the decade, the first wave of baby-boomers will begin to retire. Currently, 13% of the US population is over 65 years old. This number will increase by 50% over the next 20 years, and by 2035, 20% of the US population will be more than 65 years old. Traditionally, as people have approached retirement, they have switched their savings from equities into fixed income. We think that some retirees may choose to stay in highyielding equities as they offer a source of income and are tax-advantageous relative to most fixed-income instruments under the current law.
Exhibit 12: The number of retirees in the US will hit an inflection point later this decade percent of population 65 years-old and over

22
65+ share of US Population

20 18 16 14 12 10 1995
2005: 13% of population >65 years old 2035: 20% of population >65 years old

2005

2015

2025

2035

2045

2055

Source: UN Population Division.

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Portfolio Strategy

Share repurchases are expected to remain a competing use of cash
Prior to 2003, capital gains were taxed at a lower rate than dividends and many companies preferred to buyback shares rather than pay dividends. Repurchasing shares had the added benefit of offsetting dilution from options issuance. Following the dividend tax cut, we expected that dividends would increase. What we did not expect
was that the share repurchases would increase even more. Share repurchase announcements should continue to rise. Share repurchases appear

to have become a preferred way for many companies to return capital to shareholders. Announcements year-to-date have already exceeded total announcements in 2005 which set a record of $327 billion. This trend should continue as shareholders seem receptive to this method of returning value.
Exhibit 13: Buyback announcements have trended up substantially each year since ‘03 as of September 6, 2006
600 Stock Repurchase Program announcements ($mn) 500 400 300 200 100

$489

+50% +22% +140% (6% )
$120 $112
2003 2004 2005 2006YTD

$268

$327

0 2002

Source: Bloomberg and Goldman Sachs Research.

It is important to understand a company’s propensity to return capital to shareholders via dividends AND share repurchases. The total payout ratio, which we

define as the percentage of earnings used to buy back stock, adjusting for share issuance, plus the percentage of earnings used to pay dividends (See Exhibit 14), captures both forms of cash returned to shareholders. In 2006 year-to-date, companies have paid out 28% of earnings as dividends and used 19% of earnings to buy back stock.
Exhibit 14: If you include buybacks, the payout ratio has increased since 2004
50% 45% 40% Payout Ratio (%) 35% 30% 25% 20% 15% 10% 5% 0% Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Net Buyback Payout Ratio Dividend Payout Ratio Total Payout Ratio

Source: Compustat and Goldman Sachs Research.

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Buying opportunities exist in longer-term dividend swaps
Investors should buy the 2008 dividend swap contract for 7% upside, in our view. Our scenario analysis suggests downside risks are minimal. There are limited trading opportunities for 2006-2007 index dividends. Index dividend swaps enable investors to trade dividend performance separately from price performance. An index dividend swap is a contract that enables investors to

take a view on the future dividends to be paid on a stock index relative to the prevailing level implied by the market. Dividend swaps are market-cap weighted so larger companies are weighted more in calculating aggregate dividend levels. See Appendix A for a detailed primer on the dividend swap market.
Exhibit 15: Currently, bottom-up forecasts suggest much more upside in longer-dated dividend swaps market-implied levels as of September 25, 2006
70.00 65.00 60.00 Dividends ($/share) 55.00 50.00 45.00 40.00 35.00 30.00 25.00 20.00 Worst-case

Goldman Sachs estimates Implied Dividend Swap Level
Best-case

Best-case Scenario Goldman Sachs estimates Worst Case Scenario Implied Dividend Swap Level Upside / (Downside)(%) to Best Case Scenario to Goldman Sachs to Worst Case Scenario

2006 $25.10 24.69 24.23 24.58 2.1 0.5 (1.4)

2007 $27.91 26.52 25.43 26.67 4.7 (0.6) (4.6)

2008 $30.99 28.72 27.15 26.89 15.2 6.8 1.0

2009 $32.33 31.43 29.96 30.31 6.7 3.7 (1.1)

2010 $35.57 33.84 31.97 31.46 13.0 7.5 1.6

2011 $39.24 36.72 34.11 32.09 22.3 14.4 6.3

2012 $43.24 39.83 36.39 33.78 28.0 17.9 7.7

2013 $47.60 43.20 38.83 36.37 30.9 18.8 6.8

2014 $52.36 46.84 41.43 38.17 37.2 22.7 8.6

2015 $57.53 50.77 44.21 38.43 49.7 32.1 15.0

2016 $63.16 55.01 47.17 44.17 43.0 24.5 6.8

Source: I/B/E/S, Goldman Sachs Research estimates.

We have created three scenarios to forecast the range of dividend growth in the future. For all three scenarios, we forecast 2006-2009 dividends using bottom-up estimates and 2010 dividends and beyond using a top-down model.
Exhibit 16: Scenario analysis for estimating dividends

2006-2009
Goldman Sachs (Base-Case) Bottom-up dividend estimates 1. Goldman Sachs (if available) 2. Consensus (if available) 3. historical growth Highest of Goldman Sachs, consensus, and dividends implied by the derivatives market Lowest of Goldman Sachs, consensus, and dividends implied by the derivatives market

2010-2015
Earnings Growth 6.7% Payout Ratio 50 bp annual increase (from 29.5% to 32.5%) 100 bp annual increase (from 29.5% to 35.5%)

Best-case

6.7%

Worst-case

6.7%

0 bp annual increase (remains at 29.5%)

Source: Goldman Sachs Research estimates.

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We use a top-down model to forecast dividend growth on a longer-term basis.

While a bottom-up perspective is appropriate for thinking about near-term dividend levels, beyond four years in the future the risks outweigh the benefits of using this model. Instead, we advocate using a top-down approach based on the capacity to pay and the propensity to pay dividends. See pages 19-22 for additional details of our forecast.
• Base-case: We estimate 2006-2009 dividends using Goldman Sachs estimates when

available, and consensus when not. Long-term growth is based on S&P 500 trend earnings growth of 6.7% and a 50 basis point increase in the dividend payout ratio each year until the payout ratio equals 32.5%.
• Best-case: We estimate 2006-2009 dividends using the highest of Goldman Sachs

estimates, consensus estimates and dividends implied by the derivative market. Longterm growth is based on S&P 500 trend earnings growth of 6.7% and a 100 basis point increase in the dividend payout ratio each year until the payout ratio equals 35.5%.
• Worst-case: We estimate 2006-2009 dividends using the lowest of Goldman Sachs

estimates, consensus estimates and dividends implied by the derivative market. Longterm growth is based on S&P 500 trend earnings growth of 6.7% and a zero increase in the dividend payout ratio.

The dividend market sold off sharply in May-June along with other risky assets
The market-implied dividend levels have generally increased over the past two years and most contracts peaked in May of 2006. Since then, the implied level of dividends sold off 8%-25%. Not surprisingly, the longer-dated contracts sold off the most.
We believe that near-term contracts (2006-2007) are fairly valued and there are more opportunities as you move out the term structure to 2008 and beyond.
Exhibit 17: Market-implied dividend swap levels for 2006-2015 contracts
36.00 34.00 Implied dividend levels ($) 32.00 2009 30.00 28.00 26.00 24.00 22.00 20.00 Aug-05 Aug-06 Oct-05 Feb-05 Dec-04 Dec-05 Feb-06 Apr-05 Jun-05 Apr-06 Jun-06 Oct-06 2008 2007 2006 Implied dividend levels ($) 55.00 50.00 45.00 40.00 35.00 30.00 25.00 20.00 Apr-05 Oct-05 Apr-06 Jun-05 Feb-05 Aug-05 Feb-06 Jun-06 Aug-06 Dec-04 Dec-05 Oct-06 2015 2014 2013 2012 2011 2010

Source: Goldman Sachs Research estimates.

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The market appears to be dramatically underestimating long-term growth
Buy the 2015 dividend swap and sell the 2010 contract. The dividend term structure

implies the compound annual growth rates declines after 2010. The market-implied 5year compound annual dividend growth rate of 4% per year for 2010- 2015 is below our 8.5% estimate. Investors may implement this view with a steepening trade (sell a neardated contract and buy a long-dated contract). One risk is that the steepening occurs after the 2010 contract settles.
Exhibit 18: Currently, long-term growth is being priced at a discount market-implied levels as of September 25, 2006
12.0% Annualized 5-yr growth (%)
Best-case

10.0% 8.0% 6.0%
Worst-case

4.0% 2.0% 0.0%

Goldman Sachs estimates Implied Dividend Swap Level 20062011 8.8% 8.8 8.1 5.5 20072012 9.2% 8.4 7.8 4.8 20082013 9.6% 8.5 7.5 6.2 20092014 9.8% 8.6 7.0 4.7 20102015 10.1% 8.5 6.7 4.1 20112016 10.0% 8.5 6.7 6.6

Best-case Scenario Goldman Sachs estimates Worst Case Scenario Implied Dividend Swap Level

Source: Goldman Sachs.

We believe that 4% annualized dividend growth (or below) is extremely unlikely.

For this scenario to occur, either 2010-2015 earnings growth would have to be below trend and/or the payout ratio would need to decline each year. If any combination of long-term earnings growth and change in payout ratio results in annualized dividend growth above 4.1%, the Sell 2010/Buy 2015 trade should be profitable.
Exhibit 19: Currently, long-term growth is being priced at a discount
Market-Implied for 2010-2015 Growth Goldman Sachs estimate for 2010-2015 Growth

5-yr Dividend CAGR (2010-2015)
Annual Change in Payout Ratio -50 bp 0.2 1.2 2.2 3.2 4.1 4.8 5.1 6.1 -25 bp 1.1 2.1 3.1 4.1 5.1 5.8 6.1 7.1 0 bp 2.0 3.0 4.0 5.0 6.0 6.7 7.0 8.0 +25 bp +50 bp 2.9 3.9 4.9 5.9 6.9 7.6 7.9 8.9 3.7 4.7 5.7 6.7 7.7 +75 bp 4.5 5.5 6.5 7.5 8.6 9.3 9.6 10.6

Long-Term Earnings Growth (%)

-100 bp -75 bp 2 3 4 5 6 6.7 7 8 (1.7) (0.8) 0.2 1.2 2.1 2.8 3.1 4.1 (0.7) 0.2 1.2 2.2 3.2 3.8 4.1 5.1

+100 bp 5.2 6.3 7.3 8.3 9.4 10.1 10.4 11.4
S&P 500 Long-term EPS growth

8.5
8.8 9.8

Source: Goldman Sachs.

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Implied growth rates now appear to be positive, but are likely too conservative
For the first half of 2005, the market was discounting negative 1% to positive 3% 5-year compound annual growth. The market rallied from the fourth quarter of 2005 into the first quarter of 2006. Over this period, longer-dated contracts performed the best, leading to the upward dividend term structure we have today. In the spring, 5-year compound annual growth was implied to be 6%-9%. The market has sold off since then, and compound annual growth is now implied to be 4%-6%. In general, we believe that growth will be significantly better than what is priced into the market currently.
The 2010-2015 contract is discounting in the lowest growth rate currently (4.1%). We recommend investors buy the 2015 dividend swap and sell the 2010 contract to implement this view.
Exhibit 20: Market-implied 5-year compound annual dividend growth rates December 2004-current

11% 2006-2011 2007-2012 9% Implied 5-yrear CAGRs (%) 2008-2013 2009-2014 7% 2010-2015

5%

3% Spring: Growth WAS expected to be 7%-9%/year Now: Growth IS expected to be 4%-6%/year. We believe growth will be 8.5%/year. -2% May-05 May-06 Jan-05 Jun-05 Jan-06 Feb-05 Aug-05 Sep-05 Feb-06 Jun-06 Apr-05 Apr-06 Aug-06 Sep-06 Mar-05 Dec-04 Nov-05 Dec-05 Mar-06 Jul-05 Oct-05 Jul-06 Oct-06

1%

Source: Goldman Sachs Research estimates.

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From individual dividend estimates to a dividend swap
In order to aggregate dividends, we need to make additional assumptions about index constituents. We assume that the constituents of the S&P remain the same and that the weightings of the stocks within the index remain the same over time.
The index dividends for a particular period are the sum of the dividends of all constituents converted into dividends in index points. Dividend points depend on

the dividend yields of the constituents but also on their free-float adjusted market caps (shares outstanding x free float factor x price), which determine their dividend contribution. An example can be found in Appendix A. Currently, the largest 50 companies in the S&P 500 account for close to 60% of total dividends paid (vs. 49% of total market capitalization). This is the largest percentage in recent history. Currently, 44 of the largest 50 stocks pay a dividend.
Exhibit 21: The largest 50 stocks account for almost 60% of S&P 500 dividends 1990-2006E
65% 60% 55% 50% 45% 40% 35% Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07

Source: Compustat, Goldman Sachs Research.

Dividend surprises or corporate actions involving the biggest contributors are the dominant risk in trading index dividends. For example, BellSouth (BLS, Not Rated) is

expected to be acquired by AT&T (T, Not Rated) in the first quarter of 2007. BellSouth should account for 0.25 dividend points in 2007, which is approximately 1% of total dividends paid by the S&P 500. AT&T is currently expected to account for 0.60 dividend points. After the merger, we expect AT&T’s dividend points to increase 0.12 to 0.78. We can not determine the full effect of the merger until the replacement company is announced. We highlight the impact of upcoming corporate actions in Exhibit 33.
The largest companies not currently paying dividends could create risk to the upside. For example, if Cisco Systems (CSCO, Buy) were to initiate a dividend at a

payout ratio of 28% (equal to that of Microsoft (MSFT, Buy)), the total dividend estimate for the S&P 500 would increase by 0.25 dividend points.

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Exhibit 22: S&P 500 dividend forecasts in index points, as of September 8, 2006 Bubble size=2006 cumulative dividends in index points. Dotted line indicates S&P 500 dividend yield (1.9%)
500

400 Free-float market cap ($ bil)

XOM GE

300 C MSFT 200 AIG HPQ IBM WMT PEP INTC COP KO BLS PG JNJ CVX WFC MRK WB USB JPM PFE MO T VZ BAC

100

LLY

0 0.0 1.0 2.0 3.0 Dividend yield (2006) 4.0 5.0 6.0

Company Name General Electric Bank of America Corp. Citigroup Inc. Exxon Mobil Corp. Pfizer, Inc. Altria Group, Inc. AT & T Inc. JPMorgan Chase & Co. Verizon Communications Chevron Corp. Johnson & Johnson Procter & Gamble Wells Fargo Wachovia Corp. Merck & Co. Microsoft Corp. ConocoPhillips Coca-Cola Co. U.S. Bancorp Intel Corp. BellSouth PepsiCo Inc. Abbott Labs American Int'l. Group International Bus. Machines Wal-Mart Stores United Parcel Service Lilly (Eli) & Co. Wyeth Morgan Stanley Home Depot United Technologies Boeing Company Merrill Lynch Hewlett-Packard Time Warner Inc. QUALCOMM Inc. American Express Schlumberger Ltd. Walt Disney Co. Medtronic Inc. Motorola Inc. United Health Group Inc. Cisco Systems Google Inc. Amgen Comcast Corp. Oracle Corp. Apple Computer S&P 500

Ticker GE BAC C XOM PFE MO T JPM VZ CVX JNJ PG WFC WB MRK MSFT COP KO USB INTC BLS PEP ABT AIG IBM WMT UPS LLY WYE MS HD UTX BA MER HPQ TWX QCOM AXP SLB DIS MDT MOT UNH CSCO GOOG AMGN CMCSA ORCL AAPL S&P 500

Market Dividend Rating Cap ($ bil) Yield (%) Buy 355 2.9 Buy 237 4.3 Neutral 245 4.0 Buy 386 2.0 Not Rated 205 3.4 Neutral 172 4.2 Not Rated 128 4.0 Neutral 163 2.9 Neutral 108 4.4 Neutral 136 3.4 Not Rated 187 2.3 Neutral 196 2.0 Buy 121 3.1 Buy 88 4.1 Sell 91 3.6 Buy 230 1.5 Buy 96 2.5 Neutral 90 2.8 Buy 59 4.0 Buy 110 2.1 Not Rated 78 2.7 Neutral 106 1.9 Neutral 73 2.5 Buy 169 1.0 Neutral 124 1.5 Buy 119 1.4 NC 77 2.1 Buy 55 2.9 Neutral 67 2.0 Buy 77 1.5 Buy 74 1.7 Buy 63 1.7 Neutral 61 1.6 Neutral 69 1.3 Buy 96 0.9 Neutral 72 1.2 Buy 63 1.3 NC 66 1.1 Buy 68 0.9 Buy 63 0.9 Neutral 54 0.9 Not Rated 61 0.8 Sell 66 0.1 Buy 140 0.0 Buy 86 0.0 Buy 83 0.0 Neutral 73 0.0 Neutral 71 0.0 Buy 62 0.0 1.9

2006 Div Pts $1.18 1.07 1.06 0.85 0.78 0.77 0.58 0.52 0.52 0.49 0.47 0.43 0.40 0.38 0.37 0.35 0.28 0.28 0.27 0.26 0.23 0.21 0.21 0.19 0.19 0.18 0.18 0.17 0.15 0.13 0.14 0.11 0.11 0.10 0.10 0.09 0.08 0.07 0.07 0.06 0.05 0.04 0.00 0.00 0.00 0.00 0.00 0.00 0.00 $24.69

2007 Div Pts Growth $1.35 14.6 1.19 11.3 1.14 8.3 0.95 12.5 0.81 4.2 0.85 9.9 0.60 3.7 0.56 5.9 0.53 1.9 0.57 15.4 0.52 10.3 0.47 9.9 0.43 7.4 0.40 7.0 0.37 0.0 0.39 12.4 0.35 25.0 0.30 8.1 0.29 8.9 0.26 0.0 0.25 5.2 0.24 12.1 0.21 4.1 0.21 13.8 0.21 14.5 0.20 7.5 0.20 9.9 0.19 7.5 0.16 4.0 0.14 8.1 0.15 10.0 0.12 6.9 0.12 16.7 0.11 10.0 0.10 3.1 0.10 4.8 0.09 5.1 0.07 0.0 0.07 0.0 0.06 0.0 0.06 15.5 0.04 0.0 0.00 0.0 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM $26.52 7.4

2008 Div Pts Growth $1.55 14.4 1.32 11.0 1.23 7.7 1.06 11.1 0.84 4.0 0.94 10.1 0.63 4.3 0.59 5.6 0.54 1.8 0.66 16.4 0.58 10.6 0.51 9.0 0.47 7.8 0.45 10.9 0.37 0.0 0.43 9.8 0.40 15.8 0.33 8.2 0.32 10.2 0.26 0.0 0.26 4.9 0.26 10.8 0.22 4.0 0.25 14.9 0.23 6.3 0.21 6.9 0.22 9.6 0.20 7.0 0.16 3.8 0.16 13.3 0.17 9.1 0.13 6.4 0.12 0.0 0.12 9.1 0.11 9.1 0.10 0.0 0.09 0.9 0.07 0.0 0.07 0.0 0.06 0.0 0.07 16.5 0.04 0.0 0.00 0.0 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM $28.72 8.3

2009 Div Pts Growth $1.76 13.3 1.46 11.1 1.32 7.1 1.19 12.5 0.91 7.7 1.03 10.0 0.65 4.1 0.62 5.3 0.55 1.8 0.78 18.5 0.63 9.6 0.56 9.0 0.51 8.0 0.49 9.8 0.37 0.0 0.47 8.9 0.46 13.6 0.35 7.6 0.35 9.9 0.26 0.0 0.27 4.7 0.29 11.1 0.23 3.1 0.28 15.3 0.24 6.0 0.23 7.8 0.25 14.3 0.22 8.7 0.17 3.7 0.19 17.6 0.18 8.3 0.14 6.0 0.14 14.3 0.13 10.0 0.11 2.8 0.10 0.0 0.09 4.6 0.08 3.8 0.07 0.0 0.06 0.0 0.08 16.8 0.04 0.0 0.00 0.0 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM $31.43 9.5

Note: companies not covered (NC) by Goldman Sachs so all data is based on consensus estimates. Goldman Sachs is excluded from this table.

Source: Goldman Sachs Research estimates, I/B/E/S, IDC via FactSet.

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Analyzing dividends on a sector basis
As with stocks, a sector’s importance in the dividend market is contingent on two data points: equity capitalization and dividend yield. This leads to some sectors

having more importance on a dividend basis than they do on a market cap basis. Currently, Financials is the largest sector in the S&P 500, accounting for 22% of the market cap. Financials is even more important to the dividend market as it should account for 30% of total dividends paid in 2006. Telecom Services and Utilities also have much greater weighting on a dividend basis (both have 6% dividend weighting, twice each sector’s weighting in the S&P 500). On the other hand, Information Technology, the second-largest sector in the S&P 500 with a 15% weight, accounts for only 5% of the total dividends paid. Only one-third of the companies in Information Technology pay dividends (27 out of 81). If all the Tech companies that don’t currently pay dividends began paying out just 20% of their earnings in 2007 (compared with 23% payout ratio for those Tech companies that now pay dividends), this would add $1.20 to our 2007 dividend estimate, equal to a 4.5% boost to our base-case estimate of $26.52.
Exhibit 23: Goldman Sachs vs. the derivatives market Bubble size=2006 cumulative dividends in index points. Dotted line indicates S&P 500 dividend yield.
3000

2500

Financials

Free-float market cap ($ bil

2000

Information Technology Health Care

1500

Industrials Consumer Staples

1000

Consumer Discretionary

Energy

500 Utilities Materials 0 0.0 0.5 1.0 1.5 2.0 Dividend yield (2006) 2.5 3.0

Telecom Services

3.5

4.0

Sector Financials Industrials Consumer Staples Health Care Energy Consumer Discretionary Utilities Telecommunication Services Information Technology Materials S&P 500

Market Dividend Cap ($ trill) Yield (%) 2.6 2.5 1.3 2.0 1.2 2.2 1.5 1.6 1.1 1.8 1.2 1.2 0.4 3.4 0.4 3.3 1.8 0.7 0.3 2.2 11.8 1.9

2006 Div Pts $7.25 2.89 2.82 2.68 2.12 1.56 1.54 1.54 1.28 1.03 $24.69

2007 Div Pts Growth $7.88 8.8 3.21 11.1 3.07 8.5 2.81 5.0 2.43 14.9 1.58 1.7 1.60 3.8 1.60 3.9 1.40 9.3 0.94 (8.6) $26.52 7.4

2008 Div Pts Growth $8.61 9.1 3.63 13.2 3.34 8.8 2.96 5.2 2.74 12.7 1.69 6.6 1.64 3.1 1.65 3.1 1.50 7.2 0.97 2.7 $28.72 8.3

2009 Div Pts Growth $9.39 9.2 4.24 16.7 3.63 8.8 3.14 6.2 3.15 14.9 1.83 8.7 1.69 3.1 1.69 3.0 1.63 8.7 1.03 6.2 $31.43 9.5

Source: I/B/E/S, Goldman Sachs Research estimates.

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2006-09 scenario analysis: Considering all dividend estimates
We have three sets of estimates of dividends: Goldman Sachs, Consensus, and those implied by the options market. While the aggregate levels of all three are highly

correlated year-to-year, estimates for individual stocks vary greatly depending on which estimate is used. For the Goldman Sachs scenario (our base case) we use Goldman Sachs analyst estimates (if they exist), then consensus estimates (if they exist), and the the lower of the trailing 3year or 5-year dividend growth rate. We currently cover 363 of the 500 companies in the S&P 500, which represent 88% of the market capitalization. For the best-case scenario, we chose the highest of the three estimates for each company within the S&P 500. For the worst-case, we chose the lowest of the three estimates.

GS vs. consensus: We are slightly more positive
We believe that consensus estimates are slightly conservative. Consensus estimates

for the entire S&P 500 imply dividends would be 1%-2% lower each year through 2009.
Exhibit 24: Goldman Sachs estimates are generally above consensus

Goldman Sachs Consensus GS less Consensus % difference
Source: I/B/E/S, Goldman Sachs.

2006 $24.69 24.56 0.13 0.5%

2007 $26.52 26.15 0.37 1.4%

2008 $28.72 28.49 0.23 0.8%

2009 $31.43 30.86 0.57 1.9%

Goldman Sachs 2007 dividend estimates are above consensus for 142 companies and below consensus for 93 companies. To assess the impact of using consensus

estimates instead of Goldman Sachs on dividend swaps, we translate the dividends into dividend points. See Appendix A for a discussion of how dividend points are calculated.
We highlight the 10 companies where Goldman Sachs analyst dividend estimates are most above and below consensus. Goldman Sachs is above consensus for Energy

[primarily Chevron (CVX, Neutral), Exxon Mobil (XOM, Buy) and ConocoPhillips (COP, Buy)] and Industrials [General Electric (GE, Buy)] and below consensus for Consumer Discretionary [Ford (F, Sell) is expected to eliminate its dividend in 4Q2006] and Pharmaceutical companies [Pfizer (PFE, Not Rated)]. See Exhibit 25.

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Exhibit 25: Goldman Sachs dividend estimates vs. Consensus

2007 Dividend estimates: Goldman Sachs vs. CONSENSUS
Sector Energy Industrials Financials Information Technology Telecommunication Services Consumer Staples Materials Utilities Consumer Discretionary Health Care Dividend Points GS Consensus 2.43 2.28 3.21 3.08 7.88 7.78 1.40 1.32 1.60 1.56 3.07 3.03 0.94 0.96 1.60 1.63 1.58 1.62 2.81 2.87 Div Point Variance 0.15 0.12 0.10 0.08 0.04 0.03 (0.02) (0.03) (0.04) (0.06)

Goldman Sachs above CONSENSUS
Company General Electric ConocoPhillips Bank of America Corp. Nucor Corp. International Bus. Machines Chevron Corp. Embarq Corp. Microsoft Corp. Exxon Mobil Corp. American Int'l. Group Ticker GE COP BAC NUE IBM CVX EQ MSFT XOM AIG Rating Buy Buy Buy Buy Neutral Neutral Neutral Buy Buy Buy GS 1.18 1.90 2.36 2.50 1.26 2.32 4.34 0.41 1.44 0.74 Consensus 1.08 1.59 2.26 1.08 1.00 2.15 2.31 0.38 1.40 0.66 % Diff 9 19 4 131 26 8 88 9 3 12 Div Point Variance 0.11 0.06 0.05 0.05 0.04 0.04 0.03 0.03 0.03 0.02

Goldman Sachs below CONSENSUS
Company Pfizer, Inc. Ford Motor JPMorgan Chase & Co. Monsanto Co. Freeport-McMoran Cp & Gld Du Pont (E.I.) Exelon Corp. Schlumberger Ltd. Phelps Dodge Intel Corp. Ticker PFE F JPM MON FCX DD EXC SLB PD INTC Rating Not Rated Sell Neutral Neutral Neutral Buy Neutral Buy Buy Buy GS 1.00 0.00 1.44 0.44 1.25 1.48 1.60 0.50 0.80 0.40 Consensus 1.07 0.15 1.52 0.91 2.53 1.72 1.86 0.62 1.37 0.42 % Diff (7) (100) (5) (52) (51) (14) (14) (19) (42) (5) Div Point Variance (0.06) (0.03) (0.03) (0.03) (0.03) (0.02) (0.02) (0.02) (0.01) (0.01)

Source: I/B/E/S, Goldman Sachs Research estimates.

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The derivatives market offers alternative estimates
When pricing options, single-stock options traders must estimate the dividends they expect companies will pay over the life of the option. When a company pays a

regular dividend, the share price is reduced by the amount of the dividend, but the strike prices of the puts and calls remain the same. In order to price the option “correctly”, an accurate estimation of each company’s dividend is essential. These dividend estimates often differ from consensus dividend estimates.
On an aggregate basis, dividend estimates inferred from the derivatives market are higher than both Goldman Sachs’s and the consensus. We only have dividend

estimates through 2008 as single-stock options only trade through January 2009 at this time.
Exhibit 26: Goldman Sachs estimates are below what is implied by the options market 2006 2007 2008 Goldman Sachs $24.69 $26.52 $28.72 Derivative Market 24.70 26.94 29.44 GS less Consensus (0.00) (0.42) (0.72) % difference (0.0)% (1.6)% (2.4)%
Source: Standard & Poor's, Goldman Sachs.

Traders appear more willing than analysts to price in dividend initiations. The

derivative market implies that 22 companies will initiate dividends before the end of 2007, including Cisco Systems (CSCO), Dell (DELL), Amgen (AMGN), and Oracle (ORCL). These 22 companies account for over half the difference versus
consensus.
Exhibit 27: Companies expected to initiate dividends in 2007
Stocks that are implied to initiate dividends by the end of 2007
Company Cisco Systems Dell Inc. Amgen Caremark Rx Oracle Corp. WellPoint Inc. Agilent Technologies Intuit, Inc. Advanced Micro Devices Medco Health Solutions Inc. Sealed Air Corp.(New) Genzyme Corp. Jabil Circuit Boston Scientific Broadcom Corporation Kohl's Corp. Forest Laboratories Interpublic Group Yahoo Inc. Zimmer Holdings AutoZone Inc. Ticker CSCO DELL AMGN CMX ORCL WLP A INTU AMD MHS SEE GENZ JBL BSX BRCM KSS FRX IPG YHOO ZMH AZO Derivatives Market Consensus 0.10 0.00 0.04 0.00 0.23 0.00 0.48 0.00 0.02 0.00 0.15 0.00 0.22 0.00 0.12 0.00 0.08 0.00 0.21 0.00 0.76 0.00 0.15 0.00 0.35 0.00 0.04 0.00 0.08 0.00 0.06 0.00 0.12 0.00 0.05 0.00 0.02 0.00 0.08 0.00 0.15 0.00 Div Point Variance 0.07 0.01 0.03 0.02 0.01 0.01 0.01 0.00 0.00 0.01 0.01 0.00 0.01 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Note: Dividends are estimated based on what is priced into the options market. Covering analysts may not necessarily agree with what is priced in the market.

Source: DerivativesPac, First Call, Compustat, IDC via FactSet, Goldman Sachs Research.

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Once traders price in a dividend level, they don’t tend to assume annual increases.

For companies that pay a dividend, the options market implied zero dividend growth in 2008 for 175 companies. Consensus estimates imply zero dividend growth for only 56 companies.
We highlight the 10 companies where implied dividends vary most from Goldman Sachs estimates. The derivatives market implies higher dividends for Information

Technology (primarily Cisco (CSCO, Buy) and Intel (INTC, Buy) while Goldman Sachs is above for Industrials (primarily General Electric (GE). See Exhibit 28.
Exhibit 28: Goldman Sachs vs. the derivatives market

2007 Dividend estimates: Goldman Sachs vs. Options Implied
Sector Consumer Discretionary Utilities Financials Telecommunication Services Consumer Staples Information Technology Energy Health Care Materials Industrials Dividend Points GS Derivatives 2.43 2.47 3.21 3.14 7.88 7.89 1.40 1.56 1.60 1.66 3.07 3.06 0.94 0.96 1.60 1.63 1.58 1.70 2.81 2.88 Div Point Variance (0.04) 0.07 (0.01) (0.16) (0.06) 0.01 (0.02) (0.04) (0.12) (0.06)

Goldman Sachs above OPTIONS IMPLIED
Company General Electric ConocoPhillips Nucor Corp. Chevron Corp. Kinder Morgan Bank of America Corp. Embarq Corp. HCA Inc. Citigroup Inc. Altria Group, Inc. Ticker GE COP NUE CVX KMI BAC EQ HCA C MO Rating Buy Buy Buy Neutral NC Buy Neutral Neutral Neutral Neutral GS 1.18 1.90 2.50 2.32 3.94 2.36 4.34 0.68 2.08 3.65 Derivatives Market 1.05 1.51 0.95 2.14 0.30 2.29 2.31 0.07 2.04 3.56 % Diff 12 26 163 8 1,213 3 88 871 2 3 Div Point Variance 0.15 0.07 0.05 0.04 0.04 0.04 0.03 0.03 0.02 0.02

Goldman Sachs below OPTIONS IMPLIED
Company Exxon Mobil Corp. BellSouth Pfizer, Inc. Cisco Systems Golden West Financial Phelps Dodge Intel Corp. Ford Motor PACCAR Inc. Fannie Mae Ticker XOM BLS PFE CSCO GDW PD INTC F PCAR FNM Rating Buy Not Rated Not Rated Buy Neutral Buy Buy Sell NC NC GS 1.44 1.22 1.00 0.00 0.38 0.80 0.40 0.00 1.03 1.08 Derivatives Market 1.70 1.75 1.08 0.08 2.17 2.40 0.45 0.15 1.75 1.26 % Diff (15) (30) (7) (100) (82) (67) (11) (100) (41) (14) Div Point Variance (0.17) (0.11) (0.06) (0.05) (0.05) (0.04) (0.03) (0.03) (0.02) (0.02)

Source: I/B/E/S, Goldman Sachs Research estimates.

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Appendix A: Introduction to index dividend swaps

25 Introduction to index dividend swaps

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Introduction to index dividend swaps
What is an index dividend swap and what are its benefits?
An index dividend swap is an over-the-counter (OTC) derivative contract that enables investors to take a view on the cumulative dividends (i.e. the sum of dividends) that will be paid by the constituents of a stock index in a pre-determined time period. The dividend period is usually one year. In the United States, this period

typically is a calendar year (beginning on January 1 and ending on December 31), while in Europe, it typically starts and ends on the third Friday in December when futures expire. Investors can buy or sell dividends.
If investors buy dividends they commit to pay the prevailing market-implied level (fixed leg) multiplied by the exposure per point that they wish to obtain while the counterparty commits to pay the realized dividend level at maturity multiplied by the exposure per point (floating leg). Although the payout is based on realized

dividends, if unwound before maturity it is exposed to changes in market-implied dividend levels. There is no cash flow at the initiation of the transaction.
Exhibit 29: Investors can buy or sell dividends
Fixed amount = market level × desired exposure per point

Dividend Buyer
Realized dividend = actual dividend points × exposure per point

Dividend Seller

Source: Goldman Sachs Research.

Trading dividend swaps improves risk sharing and increases investors’ focus on the fundamentals that determine equity values because equity values and dividends should ultimately be connected via a dividend discount model. If

investors forecast index dividends correctly they will profit fully at the end of the swap period, while equity values can be subject to noise trading. Despite rapid development, the dividend swap market is still relatively young and participation is dominated by hedge funds. As a still relatively immature market with limited participation, the dividend swap market should continue to offer alpha opportunities.

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Which dividends are included?
Declared ordinary gross dividends paid on stocks going ex-dividend in that period are included. These are most likely to be recurring and thus potentially forecastable. Special or extraordinary dividends are not included in most situations. A special

dividend is usually defined as not fitting a regular payment out of operating earnings and does not have an impact on future dividend payments. Whether dividends are included in dividend swaps is guided by the index provider/exchange rules. Index providers have slightly different rules to account for characteristics of the market.
S&P defines special dividends as those dividends that are outside of the normal payment pattern established historically by the issuing corporation. These may be

described by the company as “special,” “extra,” “year-end,” or “return of capital.”
However, even if a company calls a dividend “special” but it is recurring, S&P includes it as part of its dividend per share calculation. For example, Nucor (NUE,

Buy), Freeport McMoran (FCX, Buy) and Rowan Cos (RDC, Neutral) have all paid out small, recurring “special” dividends that S&P includes. Exhibit 30 shows all special dividends paid by S&P 500 companies in 2006 so far and if they are included as part of S&P 500’s calculation. Whether a dividend is funded from operating earnings or from other sources of cash does not affect the determination of whether it is ordinary or special. Large special dividends as measured relative to the share price (more than 10%) in the last 10 years have been the $3.00 from Microsoft (ex div: 15-Nov-2004) and $2.00 from Citizen Communications (ex div 16-Aug-2004). In addition, Clear Channel Communications has announced a $3.00 special dividend to be paid in 2006.
Exhibit 30: Special dividends paid by S&P 500 in 2006 so far
S&P classifies as special dividend Yes No Yes No No Yes No No Yes No No Yes

Company name Whole Foods Market Inc Rowan Cos Inc Phelps Dodge Corp Freeport-McMoRan Copper & Gold Nucor Corp Phelps Dodge Corp Freeport-McMoRan Copper & Gold Nucor Corp Alltel Corp Freeport-McMoRan Copper & Gold Nucor Corp Clear Channel Communications

Ticker WFMI RDC PD FCX NUE PD FCX NUE AT FCX NUE CCU

Rating Neutral Neutral Buy Buy Buy Buy Buy Buy Neutral Buy Buy Buy

Ex-div date 11-Jan-06 6-Feb-06 10-Feb-06 13-Mar-06 29-Mar-06 12-May-06 13-Jun-06 28-Jun-06 6-Sep-06 12-Sep-06 27-Sep-06 NA

Amount $2.00 0.25 2.00 0.50 0.25 2.00 0.75 0.50 0.05 0.75 0.50 3.00

Type Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash Special Cash

Source: Goldman Sachs Research, Bloomberg.

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How are index dividends calculated?
To forecast or calculate index dividend levels bottom-up based on company dividend per share estimates, the dividends paid by a company during a particular period, usually a year, are added up. The cumulative dividends are then converted into index points as explained below. The sum of the dividends in index points for all companies included in the index equals the index dividend level.
Exhibit 31: Example how to calculate dividends in index points: Microsoft
Microsoft is expected to pay a dividend of $0.39 in fiscal 2007 and pays a dividend of $0.43 in fiscal 2008. Microsoft has a June fiscal year end and announced an increase effective November 2006 DPS Calendar year 2007 = DPS3Q07 = $0.10 on 15-Feb-07 + DPS4Q07 = $0.10 on 16-May-07 DPS1Q08 = $0.10 on 15-Aug-07 + DPS2Q08 = $0.11 on 15-Nov-07 Calendar 2007=$0.41 per share Microsoft has 9814.992 million shares outstanding. The free-float factor is .88. Only 8637.193 million shares are included in the S&P 500

Cumulative dividends for stock in a given year

(Cumulative DPS of stock annonced in given year) x (Free-float adjusted shares in the index) = Index Divisor
The index divisor is the current free-float adjusted market cap divided by the current S&P 500 index level Index divisor = $11.891 trillion / 1321.18 = 9,000.29 million

Cumulative dividends for =0.39 dividend points stock in a given year

Source: Goldman Sachs Research.

Our assumptions for our bottom-up index dividend estimates
We estimate 2006-2009 dividends on a bottom-up basis. For covered companies, we use the Goldman Sachs research analysts’ fiscal-year estimates. We currently cover 363 of the 500 companies in the S&P 500, which represent 88% of the market capitalization. If a company is not covered, we use consensus fiscal year estimates. If we are missing estimates in out years, we increase the previous year’s dividend using the lower of the 3year or 5-year historical dividend per share growth rate. For companies that pay multiple dividends, we assume that the split between quarterly or semi-annual dividends will stay the same going forward. We assume that ex-dates remain the same from year-to-year.

We are not adjusting for risk, which might reduce the slope of the dividend term structure, especially for long maturities. Nor do we account for market “frictions” such as transaction costs or the tax status of investors in dividend swap markets, which might also cause market-implied swap levels to deviate from the “fair” value before payments are realized.

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What drives dividends on index level?
A constituent’s cumulative dividends in index points can be split up in dividend yield (based on the cumulative dividends for the year) multiplied by the free-float-adjusted market capitalization. This reveals the two major drivers of index dividends and allows an assessment of the sensitivity of index dividends to changes at the constituent level. Index dividends depend on the dividend yields of the constituents and on their free-floatadjusted market caps (shares outstanding × free float factor × price), which determine their dividend contribution (cumulative dividends in index points / total index dividends). While there are often outliers with relatively high or low dividend yields, differences in index dividend contributions are mostly driven by different free-float-adjusted market caps. Dividend surprises or changes in index composition involving the biggest dividend contributors will have considerable impact on index dividends.
Exhibit 32: Index dividends depend on the free-float adjusted market cap and dividend yields of the constituents Bubble size = cumulative dividends in index points
140,000 Free-float adjusted market cap (mn) …and with free-float market cap 120,000 100,000 80,000 60,000 40,000 20,000 0 0% 1% 2% 3% 4% 5% 6% Cumulative dividend yield
Source: Goldman Sachs Research.

Dilutive

Accretive

Dividend contributions increase with dividend yield... Constituent with the largest dividend contribution

Index dividend yield

As a result, changes in the index composition play an important role when assessing the risk of trading index dividend views. The index composition can

change over time as a result of corporate actions or regular index reviews. Changes in index constituents can have a large impact if added or deleted constituents have a dividend yield significantly different from the index. Exhibit 32 illustrates how additions with a higher (or lower) dividend yield than the index will be accretive (or dilutive, respectively), while deletions of constituents that are accretive (dilutive) will reduce (increase) the index dividend yield. Additions or deletions that change the free-float-adjusted market cap of the index will change the index divisor. If the free-float-adjusted index market cap increases (decreases) as a result of constituent changes or rebalance reviews, the dividend contributions of the unchanged constituents will decrease (increase) and their importance when assessing risk might change. The same will occur if stocks are added to the index but none are deleted.

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Changes to the S&P 500 are made as needed, with no annual or semi-annual reconstitution. The S&P adjusts shares outstanding quarterly (on the third Friday of March, June, September, and December) and adjusts float factors annually (September). We have adjusted all out-year estimates for upcoming corporate actions for the S&P 500. To the degree that the replacement companies pay dividends, our estimates may prove conservative. We have calculated the dividends of companies that have been identified by our Equities division as potential additions. A list of upcoming corporate actions and potential additions can be found in Exhibit 33.
Exhibit 33: Companies we expect to be REMOVED from the S&P 500 due to merger or LBO activity
Target Ticker North Fork Bancorporation NFB Lucent Technologies LU Fisher Scientific FSH Golden West Financial GDW HCA Inc. HCA AmSouth Bancorporation ASO Freescale Semiconductor Inc. FSL.B Symbol Technologies SBL Constellation Energy Group CEG Keyspan Energy KSE BellSouth BLS Kinder Morgan KMI Peoples Energy PGL Univision Communications UVN Total / Average S&P 500 S&P 500 Corporate Actions as a % of Total Acquirer Capital One Financial Corp Alcatel SA Thermo Electron Corp Wachovia Corp LBO Regions Financial Corp LBO Motorola Inc Fpl Group Inc National Grid Plc At&T Inc MBO Wps Resources Corp LBO Expected Market Dividend Close Cap ($ bil) Yield (%) Q4 2006 13 3.5 Q4 2006 10 0.0 Q4 2006 10 0.0 Q4 2006 20 0.4 Q4 2006 21 1.4 Q4 2006 10 3.6 Q1 2007 15 0.0 Q1 2007 4 0.1 Q1 2007 11 2.5 Q1 2007 7 4.5 Q1 2007 78 2.7 Q1 2007 11 3.3 Q1 2007 2 5.5 Q1 2007 9 0.0 1.9 2006 Div Pts 0.05 0.00 0.00 0.01 0.03 0.04 0.00 0.00 0.03 0.04 0.23 0.04 0.01 0.00 0.48 24.69 2.0% 2007 Div Pts Growth 0.06 10.0 0.00 NM 0.00 NM 0.01 15.2 0.03 1.5 0.04 4.8 0.00 NM 0.00 0.0 0.04 33.8 0.04 1.1 0.25 5.2 0.05 11.9 0.01 0.0 0.00 NM 0.52 26.52 2.0% 7.4 2008 Div Pts Growth 0.06 8.2 0.00 NM 0.00 NM 0.01 10.5 0.03 0.0 0.04 5.5 0.00 NM 0.00 0.0 0.05 20.5 0.04 0.3 0.26 4.9 0.05 7.9 0.01 0.4 0.00 NM 0.55 28.72 1.9% 8.3 2009 Div Pts Growth 0.07 9.4 0.00 NM 0.00 NM 0.01 17.3 0.03 3.7 0.05 4.5 0.00 NM 0.00 0.0 0.05 4.5 0.04 0.3 0.27 4.7 0.09 87.1 0.01 1.7 0.00 NM 0.62 31.43 2.0% 9.5

Source: Goldman Sachs Research.

Exhibit 34: Companies we expect could be ADDED to the S&P 500
Target Ticker Avalonbay Communities Inc AVB Globalsantafe Corp GSF Accenture Ltd ACN Hudson City Bancorp Inc HCBK Seagate Technology STX C H Robinson Worldwide Inc CHRW Smith International Inc SII Garmin Ltd GRMN Peabody Energy Corp BTU Expeditors Intl Wash Inc EXPD Precision Castparts Corp PCP Cognizant Tech Solutions CTSH Memc Electronic Matrials Inc WFR Varian Medical Systems Inc VAR Directv Group Inc DTV Celgene Corp CELG Liberty Media Interactive LINTA Marvell Technology Group Ltd MRVL Nii Holdings Inc NIHD Iac/Interactivecorp IACI Sector Rating Neutral Financials Neutral Energy Buy Information Technology Financials NC Buy Information Technology NC Industrials Neutral Energy NC Consumer Discretionary Neutral Energy NC Industrials NC Industrials Buy Information Technology NC Information Technology NC Health Care Consumer Discretionary Sell Neutral Health Care NC Consumer Discretionary Buy Information Technology Telecommunication Services NC Consumer Discretionary Neutral Market Dividend Cap ($ bil) Yield (%) 8.9 2.6 11.1 1.9 15.7 1.0 6.7 2.3 10.8 1.4 7.1 1.2 7.7 0.9 5.6 1.1 9.2 0.7 9.3 0.5 8.3 0.2 10.2 0.0 6.9 0.0 6.9 0.0 14.5 0.0 14.2 0.0 13.1 0.0 9.6 0.0 8.0 0.0 5.8 0.0 2006 Div Pts 0.03 0.02 0.02 0.02 0.02 0.01 0.01 0.01 0.01 0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2007 Div Pts Growth 0.03 9.9 0.03 12.4 0.02 8.8 0.02 12.9 0.02 0.0 0.01 17.0 0.01 0.0 0.01 0.0 0.01 0.0 0.01 22.7 0.00 19.2 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 2008 Div Pts Growth 0.03 10.2 0.03 0.0 0.02 0.0 0.03 35.4 0.02 3.3 0.01 8.1 0.01 0.0 0.01 (2.0) 0.01 0.0 0.01 32.8 0.00 9.7 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 2009 Div Pts Growth 0.03 0.0 0.03 23.6 0.02 0.0 0.04 35.4 0.02 7.2 0.02 33.6 0.01 0.0 0.01 0.0 0.01 0.0 0.01 32.8 0.00 8.3 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM 0.00 NM

Source: Goldman Sachs Research.

What about market frictions and mark-to-market risk?
Market-implied index dividend levels are driven by supply and demand and depending on liquidity in the market they can deviate from actual dividends paid at maturity. Such

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market frictions pose a risk to trading dividend swaps, especially those with long maturities and thus potentially longer holding periods. Dividend swaps are marked-tomarket regularly and usually cash settled at the end of the dividend period.

Is it possible to trade options on index dividends?
Options on index dividends are not currently traded in the United States. For some indices such as EuroSTOXX50, options on dividends are available which provide a more flexible way to trade dividend risks. By buying calls or puts on dividends, investors can trade dividend views with the downside risk limited to the option premium. Investors pay the option premium to have the right and not the obligation to exercise the option on dividends. By selling calls or puts, investors can collect the option premium if they expect dividend payments to stay flat. In addition, options allow more customized strategies such as spreads or strangles. However, the pricing of options on dividends is more complex and factors such as dividend volatility have to be taken into account.

Reg AC
I, David J. Kostin, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

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Disclosures

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Coverage group(s) of stocks by primary analyst(s)
Compendium report: please see disclosures at http://www.gs.com/research/hedge.html Goldman Sachs is acting as financial advisor to Amsouth Bancorporation in an announced strategic transaction. Goldman Sachs is acting as financial advisor to Bellsouth Corporation in an announced strategic transaction. Goldman Sachs is acting as financial advisor to Freescale Semiconductor, Inc. in an announced strategic transaction. Goldman Sachs is acting as financial advisor to Johnson & Johnson in an announced strategic transaction. Goldman Sachs is acting as financial advisor to Kinder Morgan, Inc., Kinder Morgan Management, Llc, Kinder Morgan Energy Partners, L.P. in an announced strategic transaction. Goldman Sachs is acting as financial advisor to another party in an announced strategic transaction which may be material to Kinder Morgan, Inc.. Goldman Sachs is acting as financial advisor to Alcatel in an announced strategic transaction. Goldman Sachs is acting as financial advisor to Motorola, Inc. in an announced strategic transaction.

Company-specific regulatory disclosures
Compendium report: please see disclosures at http://www.gs.com/research/hedge.html

Distribution of ratings/investment banking relationships
Goldman Sachs Investment Research global coverage universe
Rating Distribution Buy Global 27% Hold 59% Sell 14% Investment Banking Relationships Buy 57% Hold 49% Sell 45%

As of July 1, 2006, Goldman Sachs Global Investment Research had investment ratings on 2,129 equity securities. Prior to June 24, 2006, Goldman Sachs utilized a relative rating system of Outperform, In-Line and Underperform, which, for the purposes of the above disclosure required by NASD/NYSE rules, equated to Buy, Hold and Sell. As of June 24, 2006, Goldman Sachs assigns stocks as Buys and Sells on various regional Investment Lists; stocks not so assigned are deemed Neutral. Such assignments equate to Buy, Hold and Sell for the purposes of the above disclosure. See 'Ratings, Coverage groups and views and related definitions' below.

Price target and rating history chart(s)
Compendium report: please see disclosures at http://www.gs.com/research.hedge.html

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Regulatory disclosures Disclosures required by United States laws and regulations
See company-specific regulatory disclosures above for any of the following disclosures required as to companies referred to in this report: manager or co-manager in a pending transaction; 1% or other ownership; compensation for certain services; types of client relationships; managed/comanaged public offerings in prior periods; directorships; market making and/or specialist role. The following are additional required disclosures: Ownership and material conflicts of interest: Goldman Sachs policy prohibits its analysts, professionals reporting to analysts and members of their households from owning securities of any company in the analyst's area of coverage. Analyst compensation: Analysts are paid in part based on the profitability of Goldman Sachs, which includes investment banking revenues. Analyst as officer or director: Goldman Sachs policy prohibits its analysts, persons reporting to analysts or members of their households from serving as an officer, director, advisory board member or employee of any company in the analyst's area of coverage. Distribution of ratings: See the distribution of ratings disclosure above. Price chart: See the price chart, with changes of ratings and price targets in prior periods, above, or, if electronic format or if with respect to multiple companies which are the subject of this report, on the Goldman Sachs website at http://www.gs.com/research/hedge.html.

Additional disclosures required under the laws and regulations of jurisdictions other than the United States
The following disclosures are those required by the jurisdiction indicated, except to the extent already made above pursuant to United States laws and regulations. Australia: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. Canada: Goldman Sachs Canada Inc. has approved of, and agreed to take responsibility for, this research in Canada if and to the extent it relates to equity securities of Canadian issuers. Analysts may conduct site visits but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits. Hong Kong: Further information on the securities of covered companies referred to in this research may be obtained on request from Goldman Sachs (Asia) L.L.C. Japan: See company-specific disclosures as to any applicable disclosures required by Japanese stock exchanges, the Japanese Securities Dealers Association or the Japanese Securities Finance Company. Korea: Further information on the subject company or companies referred to in this research may be obtained from Goldman Sachs (Asia) L.L.C., Seoul Branch. Singapore: Further information on the covered companies referred to in this research may be obtained from Goldman Sachs (Singapore) Pte. (Company Number: 198602165W). United Kingdom: Persons who would be categorized as private customers in the United Kingdom, as such term is defined in the rules of the Financial Services Authority, should read this research in conjunction with prior Goldman Sachs research on the covered companies referred to herein and should refer to the risk warnings that have been sent to them by Goldman Sachs International. A copy of these risks warnings, and a glossary of certain financial terms used in this report, are available from Goldman Sachs International on request. European Union: Disclosure information in relation to Article 4 (1) (d) and Article 6 (2) of the European Commission Directive 2003/126/EC is available at http://www.gs.com/client_services/global_investment_research/europeanpolicy.html

Ratings, coverage groups and views and related definitions
Buy (B), Neutral (N), Sell (S) – Analysts recommend stocks as Buys or Sells for inclusion on various regional Investment Lists. Being assigned a Buy or Sell on an Investment List is determined by a stock’s return potential relative to its coverage group as described below. Any stock not assigned as a Buy or a Sell on an Investment List is deemed Neutral. Each regional Investment Review Committee manages various regional Investment Lists to a global guideline of 25%-35% of stocks as Buy and 10%-15% of stocks as Sell; however, the distribution of Buys and Sells in any particular coverage group may vary as determined by the regional Investment Review Committee. Regional Conviction Buy and Sell lists represent investment recommendations focused on either the size of the potential return or the likelihood of the realization of the return. Return potential represents the price differential between the current share price and the price target expected during the time horizon associated with the price target. Price targets are required for all covered stocks. The return potential, price target and associated time horizon are stated in each report adding or reiterating an Investment List membership. Coverage groups and views: A list of all stocks in each coverage group is available by primary analyst, stock and coverage group at http://www.gs.com/research/hedge.html. The analyst assigns one of the following coverage views which represents the analyst’s investment outlook on the coverage group relative to the group’s historical fundamentals and/or valuation. Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. Not Rated (NR). The investment rating and target price, if any, have been removed pursuant to Goldman Sachs policy when Goldman Sachs is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS). Goldman Sachs Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. Coverage Suspended (CS). Goldman Sachs has suspended coverage of this company. Not Covered (NC). Goldman Sachs does not cover this company. Not Available or Not Applicable (NA). The information is not available for display or is not applicable. Not Meaningful (NM). The information is not meaningful and is therefore excluded.

Ratings, coverage views and related definitions prior to June 26, 2006
Our rating system requires that analysts rank order the stocks in their coverage groups and assign one of three investment ratings (see definitions below) within a ratings distribution guideline of no more than 25% of the stocks should be rated Outperform and no fewer than 10% rated Underperform. The analyst assigns one of three coverage views (see definitions below), which represents the analyst’s investment outlook on the coverage group relative to the group’s historical fundamentals and valuation. Each coverage group, listing all stocks covered in that group, is available by primary analyst, stock and coverage group at http://www.gs.com/research/hedge.html.

Definitions
Outperform (OP). We expect this stock to outperform the median total return for the analyst's coverage universe over the next 12 months. In-Line (IL). We expect this stock to perform in line with the median total return for the analyst's coverage universe over the next 12 months. Underperform (U). We expect this stock to underperform the median total return for the analyst's coverage universe over the next 12 months

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Coverage views: Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation. Current Investment List (CIL). We expect stocks on this list to provide an absolute total return of approximately 15%-20% over the next 12 months. We only assign this designation to stocks rated Outperform. We require a 12-month price target for stocks with this designation. Each stock on the CIL will automatically come off the list after 90 days unless renewed by the covering analyst and the relevant Regional Investment Review Committee.

Global product; distributing entities
The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy. This research is disseminated in Australia by Goldman Sachs JBWere Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Canada by Goldman Sachs Canada Inc. regarding Canadian equities and by Goldman Sachs & Co. (all other research); in Germany by Goldman Sachs & Co. oHG; in Hong Kong by Goldman Sachs (Asia) L.L.C.; in Japan by Goldman Sachs (Japan) Ltd; in the Republic of Korea by Goldman Sachs (Asia) L.L.C., Seoul Branch; in New Zealand by Goldman Sachs JBWere (NZ) Limited on behalf of Goldman Sachs; in Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W); and in the United States of America by Goldman, Sachs & Co. Goldman Sachs International has approved this research in connection with its distribution in the United Kingdom and European Union. European Union: Goldman Sachs International, authorised and regulated by the Financial Services Authority, has approved this research in connection with its distribution in the European Union and United Kingdom; Goldman, Sachs & Co. oHG, regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht, may also be distributing research in Germany

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This research is for our clients only. Other than disclosures relating to Goldman Sachs, this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Other than some industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst’s judgment. Goldman Sachs conducts a global full-service, integrated investment banking, investment management, and brokerage business. We have investment banking and other business relationships with a substantial percentage of the companies covered by our Global Investment Research Division. Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our asset management area, our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research. We and our affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research. This research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Current options disclosure documents are available from Goldman Sachs sales representatives or at http://theocc.com/publications/risks/riskstoc.pdf. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments. Our research is disseminated primarily electronically, and, in some cases, in printed form. Electronic research is simultaneously available to all clients. Disclosure information is also available at http://www.gs.com/research/hedge.html or from Research Compliance, One New York Plaza, New York, NY 10004. Copyright 2006 The Goldman Sachs Group, Inc. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of The Goldman Sachs Group, Inc.

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