# Dividend yield, does it matter by ramhood15

VIEWS: 36 PAGES: 21

• pg 1
```									Dividend yield, does it matter?

Based on Fast Forward case.
What is risk premia?
•   P(t)=Div(t+1)/(r-g)=Div(t) (1+g)/(r-g)
•   P(t+1)=Div(t+2)/(r-g)=P(t)*(1+g)
•   Thus, Exp. Returns = DivY *(1+g) +g
•   Risk premia = DivY *(1+g) +g –Rf
•   But g Rf => Risk premia  DivY *(1+ Rf)
Another argument: valuation ratios
shold be within some bound
• Conventional efficient market theory: prices
are random walk.
– Thus, neither D/P nor P/E ratios should not
have any forecasting power.
• But if we will accept that for whatever
reason DivY should be within some bound,
then either numerator or denominator
should move in a way that makes market
variables forecastable. Then what moves?
Dividend Yield

0.12

0.1

Long-term
0.08                                            Mean DivY=4.65%

0.06

0.04

0.02

0
1870   1890   1910   1930              1950   1970   1990       2010
Till next mean
crossing...
(a bit of cheating...)

• Poor job for Div growth
forecasting, R2=0.25%
• Good job for price growth
forecasting R2>30%
• Thus, it is
DENOMINATOR that
brings back DivY within
”decent” range
One year horizon
• Div growth is fairly
predictable, R2=13%
• Price changes are
almost not predictable,
Ten years Horizon

• R2=1% for DivG and
16% for PriceG.
• Note that DivG results
are not really
explainable within eff.
Mkt theory at all.
• Based on that, within
next 10 yrs we should
expect 55% drop in S&P
50
P/MA10(E)
45

40

35

30

25

20

15

10

5

0
1880   1900   1920   1940   1960   1980   2000
Forecasting from
P/smoothed E
ratio
• R2 for price growth
regression is high
(40%)
• Superior to DivY
• Forecast is really
• We cannot forecast productivity growth....
Anything new happened within the
• Share repurchases have tax advantages
w.r.t. paying simple dividends.
• Part of earnings that can be used for
dividend payout is now smaller and DivY is
underestimated w.r.t. similar number 50
years ago
• What difference does it make?
Cole,
Helwege
& Laster,
FAJ 96
Assuming both
new issues are
done at market
prices,
significant
DivY is
necessary
Cole, Helwege
& Laster,
FAJ 96 (2)
96.
• Problem: most of
options are issued at
below mkt price. Liang
and Sharpe: for 144
S&P500 firms in 97
98 0.75%
Hard assets and financial claims
diverge
Intangible investmenst (1)
• ”New economy” involves substantial
investments in intangibles.
• Accounting procedures do count activity to
promote web site as expenses but ”...they
are really investments”. Hall (2000) called it
e-capital.
• McGrattan &Prescott : understatement in
Intangible investmenst
• McGrattan &Prescott :
– understatement in earnings are about 26%
– Fits only last couple of years
• Bond & Cummins: if intangibles are
counted as R&D and marketing, then for
459 industrial firms 82-98 still there is no
explanation of overvaluation.
Demographic changes
• Affluent society is formed
• Baby boomers are educated, have money to
invest and need to save for retirement
(uncertainties related to Social Securities,
etc. )
• Thus, one-time shift in risk premium.
Inflation
• Responce to inflation is not always rational.
Modigliani & Cohn 79: People discount
dividends not at real, but at nominal rate.
Thus, when inflation is high, stock market is
undervalued, and when it is low, stock mkt
is overvalued.
• Now CPI is low...
International Evidence: Mixed
What else Dividends can tell us?
•   Let us consider 2 variables: Prices and dividends.
•   Gordon/Shapiro says, that
•   P(t)=E(k D(t+k) *(1+r)-k)P*(t)
•   P*(t)=P(t)+e(t), assume E(e(t)| P(t))=0
•   =>cov(P,P*)=cov(P,P)+cov(P, e)=var(P)
•   -1<Cov(P,P*)/(StdPStdP*)<1
•   => Std(P)/Std(P*)<1=> std(P)<Std(P*)
•   Volatility of forecast (prices) should be smaller
than volatility of payouts (dividends). But the
relationship is exactly opposite!!!!

```
To top