Article Review – The High Dividend Yield Return Advantage

This is my review of the article by Tweedy Brown Funds Inc. Some text has been copied from the article for discussion.

 

Triumph of the Optimists: 101 Years of Global Investment Returns Princeton University Press (2002), Elroy Dimson, Paul Marsh, and Mike Staunton examined the respective contributions to returns provided by capital gains and dividends from 1900 to 2000.

 

Over 101 years, they found that a market-oriented portfolio, which included reinvested dividends, would have generated nearly 85 times the wealth generated by the same portfolio relying solely on capital gains.  This wealth accumulation would, of course, have been lower if dividends were not assumed to have been reinvested.

 

In an editorial in the Financial Analysts Journal in 2003, entitled Dividends and the Three Dwarfs, Robert D. Arnott examined the various components of equity returns for the 200 years ending in 2002.  He concluded that dividends were far and away the main source of the real return one would expect from stocks, dwarfing the other constituents: inflation, rising valuations, and growth in dividends.  In the chart below, Arnott shows the contribution to total return for each of these constituents for the period 1802 to 2002.  The total annualized return for the period of 7.9% consisted of a 5% return from dividends, a 1.4% return from inflation, a 0.6% return from rising valuation levels, and a 0.8% return from real growth in dividends.  He concludes that “… unless corporate managers can provide sharply higher real growth in earnings, dividends are the main source of the real return we expect from stocks.”

 

Professor Siegel also coined the terms “bear market protector” and “return accelerator” to describe how dividend reinvestment during stock market declines can dramatically lessen the time necessary to recoup portfolio losses.

 

In a recent 36-year study conducted by Lehman Brothers equity research group in September 2005, high dividend yield stocks were found to have produced more return with less risk than their low-yield counterparts.  The Lehman analysts studied the one thousand largest of U.S. firms ranked by market capitalization, and rebalanced these securities quarterly, starting in January 1970.  They found that the top-yielding quintile produced a 13.7% equal-weighted total return per year with a 15.5% standard deviation of return.  The bottom-yielding quintile, in comparison, returned 9.0% with a 29.1% standard deviation.

 

Arithmetically, the lower the pay-out ratio associated with a given level of dividend yield, the higher the earnings yield for the company, and the cheaper the stock based on price-to earnings multiples:  The high yield, low pay-out stocks that produced the better returns were priced at low ratios of price-to-earnings, and as a corollary, at high ratios of earnings-to-price; i.e., earnings yield.

 

 

 

There are 8 conclusions .. but 1st two very relevant:

 

1. Over the last 100 plus years, an investment in a market-oriented portfolio that included, most importantly, reinvested dividends, would have produced 85 times the wealth generated by the same portfolio relying solely on capital gains.

 

2. There is substantial empirical evidence to support a direct correlation between high dividend yields and attractive total returns.

 

Over the last 100 plus years, an investment in a market-oriented portfolio that included, most importantly, reinvested dividends, would have produced 85 times the wealth generated by the same portfolio relying solely on capital gains. 2. There is substantial empirical evidence to support a direct correlation between high dividend yields and attractive total returns.

 

Now clearly this is one side of a coin and there is also research and articles pointing out that taking a higher risk, higher growth, lower yield strategy would produce higher total returns. Perhaps true, but the real point here is that picking solid (if unfashionable) holdings and reinvesting the yield will generate high (and perhaps very high) returns over a long period of time. In an earlier article on compounding I mused that the real value of compounding should be viewed as being able to produce higher income streams with lower risks. This article seems to rather bear that out.

 

It should be noted though that all of this is over the long term (decades). I wonder if in the middle of an accumulation phase for example 10 years from retiring we had another 1970’s Oil Crisis where stock markets plunged 90% in some cases.

 

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