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, R2 is about 1% 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 bad.. • We cannot forecast productivity growth.... Anything new happened within the last 30 years? Share buybacks • 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 buybacks and new issues are done at market prices, significant adjustment for DivY is necessary Cole, Helwege & Laster, FAJ 96 (2) • Adjustment of 0.8% in 96. • Problem: most of options are issued at below mkt price. Liang and Sharpe: for 144 S&P500 firms in 97 adjustment is 1.39%, in 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 earnings are about 26% 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!!!!
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