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The last couple of posts in The Dividend Key series have covered high dividend stocks and the fact that they have been better market performers than low yield stocks. However, it has not been simply buying all the high dividend stocks that has been the most powerful. A study conducted by Credit Suisse Quantitative Equity Research looked at high yields and payout ratios. Their study found that it is high yields coupled with low payout ratios that have provided the best gains over lower yield investing. Although the study used a shorter time frame (1980 – 2006) than many of the other studies we have looked at, the data is pretty clear in its messaging. Take a look at the chart below:
Click to EnlargeIt is interesting to see that the stocks that had a high payout ratio as a whole produced worse gains than the S&P 500, but the stocks that either paid no dividends, had a low yield, or had a high yield did better than the S&P 500. That payout ratio is certainly more important than I thought it was based on this study. A high payout ratio can certain indicate trouble in a company and must be watched closely.
Source: Tweedy Browne Company LLC (link opens a .pdf document)
(Photo Credit: daniel wildman)
Is it feasible to trade between these securities to take advantage of high payout ratios but quickly move to low payout ratio’d securities to limit risk at a moment’s notice?
I agree somewhat, but the justification from not reading your article is that a low payout couple with a good return on equity, will improve future operating cashflow, thereby improving future yield. That is why it is a winning formula.
I am also an avid yield investor. Hope to learn from you as well.
Drizzt
http://www.investmentmoats.com
I’m new to yield investing and was wondering what is considered a high or low yield? Is 7% high, medium or low? The article wasn’t clear on this point. Also, what is a low payout ratio? I’ve been reading a fair bit and haven’t come across this tidbit yet.
Richard: interesting question but I am not sure of the answer. I am always cautious about trading and what you are describing kinda sounds like market timing, which is very difficult to get right.
Dirizzt: Good point – one cannot base a decision solely on this factor alone.
Robin: Depends on the stock – that way I look at is from an individual stock perspective and the average yield for that stock for over say, 10 years. If the yield is way higher than the average, you have a high yield. Again, a low paoyout ratio depends on the stock – some consistently have high ones (70%+) and some are low (~30%). Good question.
as a surrogate for payout ratio, i would suggest taking a hop over to the SEC (http://www.sec.gov/edgar/searchedgar/companysearch.html) and simply checking an old 10-k, from about four years ago. the statistic sought: shares outstanding. a company that keeps the share count AND the dividend stable is a dependable company! realistically there is going to be some dilution if the company is growing, but no more than a couple % per year.
One of my favorite mantras “High Yields and Low Payout Ratios.” I would much rather own a low payout ratio stock that can raise dividends going forward.