James Seaton

International Evidence on the Payout Ratio, Earnings, Dividends, and Returns

Recent evidence for the U.S. market has shown that, contrary to popular wisdom, the greater the proportion of earnings paid out as dividends, the greater the subsequent real earnings growth. This study extends previous work by examining whether a similar relationship exists in 11 international markets and by considering the role the payout ratio plays in explaining future real dividend growth and returns. Higher payout ratios do indeed lead to higher real earnings growth—but not to higher real dividend growth. This information has limited use, however, for predicting future returns. Although the payout ratio has long been of importance to corporate finance researchers, it has been relatively neglected in the asset-pricing and prediction literature, despite market fascination with investment strategies based on dividends and earnings (e.g., the “Dow 10”). Recent research has established the somewhat surprising result that higher aggregate payout ratios for the United States are associated with higher future earnings growth. This finding offers support for theories that view dividends as signals for earnings expectations. Our article contributes to the literature by investigating whether similar conclusions can be drawn about 11 major international markets and by extending the analysis to consider the relationship between payout ratio and returns, which we believe to be important because returns are the ultimate focus of portfolio managers and investment strategists. For each country, we used monthly values of the dividend yield, earnings yield, a retail price index or consumer price index (as appropriate), and the stock market index level. We also constructed a return series for each countrys index. We investigated the explanatory power of the following variables: payout ratio, dividend yield, earnings yield, lagged dividend growth, and lagged earnings growth. We examined three time periods (determined by data availability) and for the lagged variables used lags of 10 years, 5 years, and 1 year—depending on the length of the sample period. We found that, despite the different institutional, tax, and legal environments of the 11 countries, substantial reinvestment of retained earnings did not increase future real earnings growth, although it did produce faster real dividend growth. Investing in the countries with the higher payout ratios also resulted in higher earnings growth. Unfortunately, these findings did not translate to return predictability in a persuasive fashion: The results varied by country and time period. The notable exception was the U.S. market, where we found the payout ratio to be a significant variable in explaining subsequent 5-year and 10-year returns. Currently, the components of the S&P 500 are paying out around one-third of their earnings as dividends, well below the post-World War II average of 50-60 percent. Therefore, our findings suggest that the outlook for earnings growth in the next few years is ominous.

Price and Momentum as Robust Tactical Approaches to Global Equity Investing

This article investigates the performance of momentum and timing approaches for investing across 32 international equity markets, adding to a growing body of literature, which includes Siegel [2002] and Faber [2007, 2009], using data back to 1971. Momentum strategies are found to be profitable using a global portfolio, although the outperformance has diminished somewhat in the last two decades. The authors find that a trend following method significantly reduces the volatility of international equities and provides superior risk-adjusted returns compared to a conventional buy-and-hold method. Finally, the authors observe that the performance of portfolio momentum “winners” can be improved still further by the addition of a trend following filter.

Dividend yield investment strategies, the payout ratio and zero dividend stocks

This study considers the application of both high-and zero-dividend strategies to the U.K. market. Following recent academic studies we conjecture that the payout ratio may provide a useful additional filter for portfolio construction and that zero-dividend stocks may also offer higher returns. These strategies do indeed outperform both the high-yield and index returns on an absolute basis but not when adjusted for risk and transaction costs.

Dividends and Momentum

This article investigates the relationship that exists between dividend yield and momentum strategies. Both have been shown to explain the cross-section of returns, and yet they are negatively related to each other. The article finds that the outperformance of zero dividend stocks disappears when returns are measured on a value-weighted basis. Both value and momentum strategies work when the other is controlled for, although momentum is found to be the more statistically significant effect. Momentum seems to be most effective in lower dividend yield quintiles. When 130/30 portfolios were formed, this generated several percentage points of return on an annualized basis, although there was a broadly commensurate increase in volatility.

Does the fed model travel well

Equity markets are frequently valued on the basis of the relative yields of stocks and bonds. The most widely known of these comparisons is the Fed model; stocks are considered cheap when their earnings yield exceeds a long bond yield. Comparisons examining the performance of this metric and more traditional valuation measures such as earnings and dividend yields in six international markets are interesting. The Fed model turns out to be poor in explaining long-run returns, while it has some merit as a short-term tactical asset allocation tool.

Trend Following and Momentum Strategies for Global REITs

This study investigates whether the risk adjusted returns of a global REIT portfolio would be enhanced by adopting a trend following strategy (which is an absolute concept), a momentum based strategy (which is a relative concept and requires individual country allocations), or indeed a combination of the two. We examine the results in terms of both a dedicated Global REIT exposure, and the impact on a multi-asset portfolio. We find that the main improvements arise when the broad index is replaced with one of the four trend following (TF) strategies. The portfolios deliver similar returns but volatility is reduced by up to a quarter to the 8-9% range, the Sharpe ratios increase by 0.1 to 0.5 with the main benefit being the reduction in the maximum drawdown to under 30% compared to 43% when the broad index was used. We thus find that a combined momentum and trend following Global REIT strategy can be beneficial for both a dedicated REIT portfolio and adding REITs to a multi-asset portfolio.

Very long term equity investment strategies: real stock prices and mean reversion.

Recent popular research has suggested that it is possible to time the U.S. equity market over long investment horizons by looking at the real value of the aggregate stock market index relative to an average of the recent past levels. This article shows that this is not the case and that a simple buy-and-hold equity strategy dominates for nearly all time periods for both the U.S. and the U.K. in the 20th century. However, the aggregate real stock price is a more useful long-run valuation metric than incorporating dividend and earnings information, a result that has potential value for investment managers, given the problems with definitions and consistency of these variables.

Carry and Trend Following Returns in the Foreign Exchange Market

Recent research has confirmed the behaviour of traders that significant excess returns can be achieved from following the predictions of the carry trade which involves buying currencies with relatively high short-term interest rates, or equivalently a high forward premium, and selling those with relatively low interest rates. This paper shows that similar-sized excess returns can be achieved by following a trend-following strategy which buys long positions in currencies that have achieved positive returns and otherwise holds cash. We demonstrate that market risk is an important determinant of carry returns but that the standard unconditional CAPM is inadequate in explaining the cross-section of forward premium ordered portfolio returns. We also show that the downside risk CAPM fails to explain this cross-section, in contrast to recent literature. A conditional CAPM which makes the impact of the market return as a risk factor depend on a measure of market liquidity performs very well in explaining more than 90% of the variation in portfolio returns and more than 90% of the average returns to the carry trade. Trend following is found to provide a significant hedge against these risks. The performance of the trend following factor is more surprising given that it does not have the negative skewness or maximum drawdown characteristic which is shown by the carry trade factor.

Tactical Equity Investing Across Bull and Bear Markets

This article investigates the influence that the market state (bull versus bear) has on investment strategies based on characteristics such as size, value, and momentum. The authors find that the precise definition of positive and negative markets has a substantial effect on the results, with shorter-term definitions proving to be more useful. Size effects are largely confined to positive market states, while value, as defined by dividend yield, has defensive characteristics and outperforms during negative periods. Momentum, in contrast, provides positive excess returns across both market states. This result persists when size and value are controlled for in all but the very smallest of stocks. The authors show that portfolio performance can be improved by investing tactically using market state analysis.

Size Matters: Tail Risk, Momentum and Trend Following in International Equity Portfolios

The authors investigate the relationship between size and momentum across a wide range of international equity markets. They distinguish between relative momentum, where by assets are ranked according to their performance against each other, and absolute momentum (or trend following), where by assets are categorized according to whether they have recently exhibited positive, nominal return characteristics. They find only limited evidence for the outperformance of relative momentum portfolios. Trend following, however, is observed to be a very effective strategy over the study period, delivering superior risk-adjusted returns across a range of size categories in both developed and emerging markets while not reversing the performance superiority of smaller firms. The authors also find, contrary to popular perception, that it is the mid-cap sector that dominates in emerging markets, and they suggest that this sector should be considered as being equivalent to developed economy small-cap investing.