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Posted
10/17/2002 |
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Related Sites
"Dividends,
share repurchaces and the substitution hypothesis," by Grullon and
Michaely (PDF)
"Triumph
of the Optimists" at
Amazon.com
The Speculator
Recent articles:
• What dividends
say about a stock, 10/10/2002
• The earnings
gimmicks roll on, 10/3/2002
• Count on a
company's cold, hard cash flow, 9/26/2002
More...
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The Speculator
Higher dividends are no magic
bullet
The
market waters are murky when it comes to what dividends bode for
stock performance. In 2002, the top 10 highest-yielding companies
fared worse than the market -- by a good 10%.
By Victor
Niederhoffer and Laurel Kenner
Dividends are good, and everyone wants them. That
was the message we heard from thousands of readers who wrote in
response to our report last week on the benefits of higher yields,
dividend increases and repurchases. We also received thousands of
requests for Paul DeRosa's article, which pointed out that based on
earnings growth and earnings yield, the stock market was a good buy.
Only John
Clarke of Highland, Mich., exposed the irony of our turning to
fundamental analysis. Vic's idée fixe, after all, has long been that
the interactions between market prices alone are sufficient to
generate profitable predictions. "The SPECULATOR talking about
dividends as a valuable investment criterion! Now I know I'm in
Kansas."
And one lawyer/CFA, whose name we withhold out of
respect for his candor, suggested that a change in cycle may be
imminent: "Have you considered comparing the excessive relative
outperformance of the value style to the growth style? With all the
'dumb' money now chasing value (and bonds) one has to wonder what
catalyst will cause a reversion away from said style of
investment."
There's considerable wisdom in that observation,
as we'll show below. By the time Vic and his ilk are ready to study
value, chances are that tech will be back. Indeed, our Wednesday
evening column was followed by a 13% rally in S&P 500 ($INX)
futures over the next four days, but the Nasdaq Composite ($COMPX)
was up 15%. We won't take credit for the rally after our bullish
column, nor the declines that followed our June 13 "Invasion of the
body snatchers" lament concerning the excessively bearish no-hope
meme then making the rounds.
We'll give chapter and verse on
dividends, as readers requested. But first, we'll start with some of
the key insights we received in e-mail. As we discovered yet again,
our readers collectively and individually know much more than we do.
They each have their niches, their special areas of knowledge and
attention. And by tapping into their wisdom we are able to provide
an infinitely better column than if we tried to interview experts or
relied on our own expertise.
I thought your column today started to get at the heart of
the problem in the market. If investors are not receiving tangible
benefits from their stocks, like dividends or buybacks, then you
have to invest on complete faith. Faith is fine during bull
markets, but during bear markets, faith is lost. (David
Shapiro)
Until the stock market is straight with me,
it's not getting any more of my money. And I'm not putting money
in bonds now when they're at 40-year highs. Increasing dividends
and eliminating the shenanigans you pointed out in your article
would be a good way to mitigate risk and would make me take
notice. (Carey Abbott)
My father-in-law (now
deceased) looked only at dividends for his personal support and
never concerned himself with the value of his portfolio. He always
talked about "getting raises." During market downturns, he worried
not at all; he just didn't buy a new car or a new boat at those
times. He only concerned himself with the security of the
dividends. He retired at 50 and died at 90, having lived a very
nice lifestyle, with a net worth that increased 10-fold during
that period of investment. (Patricia K.
Schwabacher)
You can fake or inflate earnings, but if
you pay out cash, you had to have it in the first place. (Paul
Fels)
Despite the tax disadvantage, dividend payments at
least place control of the money with stockholders instead of the
CEOs and their ineffective and all-too-compliant boards.
(Ronald N. Woody) An October 1998 study by the American
Council for Capital Formation found that the United States taxes
dividends more heavily than most other industrialized countries. In
Taiwan, one of the great success stories of modern capitalism, the
first $8,273 of dividends from local companies is tax-exempt. Some
international readers rubbed it in:
Given Canada's preferential treatment of dividends, we find
many of the U.S. dividend-paying stocks very attractive at this
point! (Chris Kaczur)
In Australia, the Labour
government during the 1980s abolished the double taxation of
dividends … the result is that Australian companies pay some of
the highest dividend yields in the world. (Jeremy
Dunkel) Richard Mark, a lecturer in finance at Dowling College,
wrote that the main reason companies haven't been paying dividends
is not the double tax, however, but a desire to retain earnings for
misguided diversification projects, if not outright theft by senior
managers. Some readers noted that there are ways of getting around
the U.S. dividend tax with self-directed IRAs and New York Stock
Exchange-listed Master Limited Partnership stocks.
Mopping up
Let's mop up -- one of the
keys to victory in games, markets and research. We reported that
companies that paid out a high yield relative to their price tend to
outperform those that paid low dividends relative to price. The
classic reference on this is in, as usually, that magnificent book,
"Triumph of the Optimists," which we can never recommend too highly
or too frequently. The authors show that a dollar invested in
randomly selected U.S. equities at the beginning of 1900 comes to
$16,800 at the end of 2001, but to only $2,000 without reinvested
dividends.
Within that juggernaut of increasing wealth, the
rewards from investing in high-yield stocks are superior to
investing in low-yield stocks. In particular, the annualized yield
on high-yield companies comes to 12.2% from 1926 to 2000, versus
10.4% for low-yield stocks. The difference of 2% per year has a
large impact over the 74 years considered: $1 invested in the
high-yielders comes to $5,000, versus just $1,500 for the
low-yielders.
It appears, however, that the margin of
superiority for high-yielders versus low-yielders has been close to
zero since 1990. Thus, it seemed time for the Speculators to take
the pencil to the envelope again and to update the
dividend-yield-versus-return work for the 21st
century.
Before entering into the nitty-gritty of what's been
working and what hasn't vis-à-vis dividends recently, it's important
to lay a foundation. An August article in the Journal of Finance by
Gustavo Grullon of Rice University and Roni Michaely of Cornell
University, covering 1980 to 2002, does this admirably. The authors
show that as of the year 2000, stock buybacks became more important
than cash dividends in terms of return to investors. They concluded
that while stock buybacks are still more efficient than cash
dividends because of the tax factor, they both signal efficient use
of corporate funds by management. (Use the link at left to read the
article.)
Furthermore, they conclude that the apparent
superior performance that stocks have been showing vis-à-vis the
cash dividends in recent years, even though cash dividend yields
have been low by historic standards, is not anomalous at all. They
conclude it is merely a reflection that many companies have replaced
dividends with stock buybacks, and that taking account of the cash
payout to stockholders from both sources, the valuation of stocks
has been in line with traditional standards. However, they are
silent on the question of whether buyback stocks or
high-dividend-yielding companies show superior subsequent
performance.
We considered the S&P 500 companies that
showed the highest yields at year-end 2000 and year-end 2001, and
their performance in the next year:
| Changing cycles: Performance of top 10
dividend-yield stocks (2001 vs. 2002) |
| Company |
Yield at yr-end 2001 |
2002 YTD performance |
Company |
Yield at yr-end 2000 |
2001 performance |
| Plum Creek Timber (PCL) |
10.05 |
-27.1% |
Sabre (TSG) |
12.06 |
-1.8 |
| Dana (DCN) |
6.77 |
-23.7% |
J.C.Penney (JCP) |
10.47 |
155.79 |
| Ford Motor (F) |
6.68 |
-46.6% |
Rockwell Automation (ROK) |
8.48 |
-15.51 |
| J.C.Penney (JCP) |
6.44 |
-45.5% |
Dana (DCN) |
8.1 |
-3.34 |
| Rockwell Automation (ROK) |
6.34 |
-10.4% |
Ford Motor (F) |
7.68 |
-29.27 |
| CMS Energy (CMS) |
6.08 |
-70.0% |
Deluxe (DLX) |
7.33 |
116.65 |
| Eastman Kodak (EK) |
6.01 |
-10.8% |
Winn-Dixie Stores (WIN) |
7.09 |
-23.52 |
| Ameren (AEE) |
6 |
-1.8% |
Thomas & Betts (TNB) |
6.92 |
34.92 |
| RJ Reynolds Tobacco (RJR) |
5.86 |
-39.1% |
Wachovia (WB) |
6.9 |
16.47 |
| CenterPoint Energy (CNP) |
5.66 |
-67.4% |
Southern Co. (SO) |
6.6 |
31.95 |
|
|
|
|
|
|
|
Average |
-34.24% |
|
Average |
8.16 |
|
Std Dev |
23.59% |
|
Std Dev |
1.77 | |
Note
that the top 10 high-yield stocks outperformed the market in 2001,
with a positive return of 8%, versus a loss of 10% in the S&P
500 and a 39% loss in the Nasdaq. But in 2002, the effect has not
held up: The top 10 high-yield stocks are down 34%. That's even
worse than the 24% loss in the S&P 500, and exactly even with
the 34% loss in the Nasdaq.
The numbers were similar for the
top 30 high-yielders. These stocks were little changed in 2001, and
are down 25% year to date.
Some particularly egregious
examples of high-yielding stocks with disastrous returns in 2002 are
listed below:
| High-yielding stocks with poor
returns |
| Company |
Yield at year-end 2001 |
YTD performance |
| Allegheny Energy (AYE) |
4.75% |
-87% |
| TXU Corp. (TXU) |
5.09% |
-75% |
| Xcel Energy (XEL) |
5.41% |
-68% |
| Allegheny Technologies (ATI) |
4.78% |
-58% |
| Public Service Enterprise (PEG) |
5.12% |
-32% | |
It's
interesting to note that academic studies of the superior returns to
high dividend-yielding companies find that the outperformance is
particularly glaring in the month of January, but not so much in the
other 11 months of the year.
No magic
bullet
We turn now to the question whether dividend
increases are good for performance. The academics have concluded
that dividend increases are irrelevant. Recent studies from Finland
to the United States have verified this. In the scientific
tradition, we vetted their conclusions.
We looked at the 120
companies in the S&P 500 that increased their dividends in 2002.
Their cumulative performance year to date is -14%. Twenty-two
companies decreased their dividends, and their performance was -20%.
This difference is significant at the usual statistical levels.
Thus, dividend increases have been good in 2002.
Procter
& Gamble (PG,
news,
msgs),
Clorox (CLX,
news,
msgs),
Meredith (MDP,
news,
msgs),
Coca-Cola (KO,
news,
msgs)
and Merck (MRK,
news,
msgs)
were among the companies that did particularly well after raising
dividends, with respective gains of 156%, 25%, 25%, 9% and 4%. We
are not taking a position on these stocks, merely reporting what we
found.
The great danger in buying high-yield stocks is that
dividends may be cut. Look at what happened to the stocks of 14
S&P 500 companies that did so this year:
| S&P 500 companies with dividend
cuts in 2002 |
| Company |
Date of dividend cut |
Performance since dividend cut
(%) |
| Ford Motor (F) |
1/11/2002 |
-46 |
| Dynegy (DYN) |
8/12/2002 |
-45 |
| Goodrich (GR) |
5/17/2002 |
-45 |
| Transocean (RIG) |
6/14/2002 |
-43 |
| Qwest Communications (Q) |
6/24/2002 |
-42 |
| U.S. Steel (X) |
1/29/2002 |
-39 |
| Millipore (MIL) |
2/4/2002 |
-31 |
| CenterPoint Energy (CNP) |
8/8/2002 |
-25 |
| Pall (PLL) |
4/17/2002 |
-25 |
| Xcel Energy (XEL) |
9/26/2002 |
-23 |
| CMS Energy (CMS) |
8/1/2002 |
-17 |
| Bausch & Lomb (BOL) |
4/25/2002 |
-13 |
| Winn-Dixie (WIN) |
1/22/2002 |
25 |
| Williams Cos. (WMB) |
7/22/2002 |
45 | |
Our
results suggest that there is no magic bullet for stocks. High-yield
companies seem to show superior performance over time, but that
effect apparently vanished in the difficult year of 2002. Companies
that increase dividends have had relatively woeful performance in
the past, but in these times they augur good performance.
We
previously reported that companies engaged in stock buybacks
outperformed in all historical and prospective periods that we
tested. We looked at it in early 2002, and the predicted
outperformance did materialize. Perhaps we could attempt a
synthesis.
How to know when the cycle will turn? We don't.
Valuation, segment analysis and timing are all key to achieving
superior returns. Like all things in life, there's no one path to
glory.
Final note
In 1930s
Los Angeles, corruption among police and politicians inspired film
noir and a fiction genre of brilliant but moody detectives like
Raymond Chandler's Philip Marlowe. Public revulsion against the mob
eventually led to a top-down housecleaning. True-crime and detective
stories like "Monk," "CSI" and "Crossing Jordan" are so hot on TV
right now, that we wonder if they signal a new "lean and mean"
regime where companies that produce low-priced, no-nonsense goods
move into the fore. We see bullish signs, meanwhile, in forthcoming
epic films on the ancient Greek heroes Achilles and Hector, the
empire builder Hannibal and Patrick O'Brian's British Navy captain,
Jack Aubrey. The emphasis on heroism signals a much more positive
spirit toward achievement and enterprise.
At the time of
publication, neither Victor Niederhoffer nor Laurel Kenner owned or
controlled any of the securities mentioned in this
article.
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