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Are large dividend payouts really a precursor to inferior performance?
Many investors think so, but research from Credit Suisse shows otherwise. Large dividend payouts are actually correlated with superior performance.
Credit Suisse examined the dividend yield on S&P 500 companies from 1980 through 2008. The Swiss bank found that companies that paid higher-yield dividends outperformed those that paid lower-yield dividends.
But there is a catch … Credit Suisse’s research found that the highest dividend-yield stocks performed a notch lower than the second- and third-tier dividend-yield stocks.
After sectioning the S&P 500 into equal deciles, Credit Suisse found that the best performers were those slotted into deciles eight and nine. (The highest-yield stocks comprised decile 10.) You want high yield, you just don’t want the highest yield.
This makes sense because the highest dividend yields are frequently priced for a dividend cut. The price drops, so the yield rises, but only because investors anticipate a drop in yield: A $20 stock pays a $2-per-share dividend to produce a 10% yield. Should the share price drop to $10, the yield rises to 20%. That is, until the dividend is cut to $1 per share, which drops the yield back to 10%.
So, you want higher yield, but you also want a high likelihood the company will maintain the high yield. Credit Suisse’s data show that stable high-yield dividends are maintained by companies that pay a smaller percentage of their earnings as dividends.
It wasn’t always that way. Back in antiquity, companies pushed out as much of their earnings to investors as they could. From 1870 through 1945, the average dividend payout ratio was 70%, which means 70% of earnings were paid as dividends.
A hundred years ago, a 70% payout ratio meant that dividend payouts oscillated year to year. One year, a company would earn $1 per share; it would pay a $0.70 per-share dividend. The next year, it would earn $0.50 per share; it would pay a $0.35 per-share dividend.
Today, 50% is the average dividend payout ratio. Investors demand stability. Earnings might oscillate, but the dividend payout must remain steady. Companies that pay higher-yield dividends that consume a small percentage of earnings perform best.
Source: Credit Suisse
To be sure, a high yield matters, but so does the percentage of earnings required to support the high yield. A high yield supported by a large percentage of earnings underwriting the dividend suggests an at-risk dividend.
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Investors in other countries exhibit a similar preference for high-yield dividends combined with low dividend-payout ratios as investors in the United States: Investors in Canada, China, France, Japan, and the United Kingdom all value high-yield and low payout ratios.
Some foreign investors, though, just like high-yield dividends. Australian, German, and Swiss investors actually value high-yield and a high dividend payout ratio. This suggests they value the highest dividend payout possible above all else. Risk of a dividend cut apparently is no overarching concern.
Global appeal is the one constant. Investors around the world favor high-yield dividends over low-yield or no dividends. When you factor in dividends’ contribution to total return, it’s easy to understand why.
We’ve noticed more companies announcing large one-time dividends in recent weeks. We’re not surprised: dividend announcements frequently accompany quarterly financial reports. So far, though, none of the companies announcing special dividends have met our criteria. We’re not discouraged. We expect more special-dividend announcements in the coming weeks – so stay tuned…
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