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

Abstract

• We investigated whether similar findings are evident in 11 major international markets.• We extended the analysis to the relationship between the payout ratio and returns, which we believe to be important because returns are the ultimate focus of portfolio managers and investment strategists. Although the payout ratio has long been of importance to corporate finance researchers (e.g., Lintner 1956), it has been relatively neglected in the asset-pricing and prediction literature (see McManus, ap Gwilym, and Thomas 2004; ap Gwilym, Seaton, and Thomas, forthcoming 2005)-despite market fascination with investment strategies based on dividends and earnings (e.g., the "Dow 10" strategy).1 A&A redressed this omission in the literature by examining the aggregate payout ratio for U.S. stocks since 1871 and its relationship to subsequent 10-year real earnings growth. They found a positive coefficient on the payout ratio in a simple linear regression for a variety of subperiods and suggested that the low payout ratio of 2001 would lead to low earnings growth in the following decade. In their analysis of 5-year earnings growth and a rolling 30-year period, they found that these results are robust.Because dividends are "stickier" (more stable over time) than earnings, A&A also examined whether the phenomenon is actually reflecting mean reversion in earnings; a transient drop in earnings would raise the payout ratio and signal a future rebound in earnings, implying that dividend policy is not really useful as a predictor. They tested this question empirically by including past real earnings growth in the regression, but the hypothesis that the payout ratio is reflecting mean reversion in earnings was comprehensively rejected. Other possible predictor market variables (such as the yield-curve slope and earnings yield) were included, but the inference remained the same: A high payout ratio is associated with high subsequent earnings growth.Market strategists are also paying more attention to dividends and payout ratios as the markets enter an era that many believe may be unexciting for equities (see Perkins and Gavrina 2004). With the global dividend yield declining from more than 5 percent in the 1980s to less than 2 percent by the late 1990s and with the payout ratio peaking in the early 1990s but currently low, investors are being reminded of the importance of dividends to long-run total returns. Low payout ratios at least Owain

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