• Introduction: The Middle 50% Offer Better Opportunities
• Dissecting Dividend Payers
o History
o Cash
o Current Yield
o Valuation
o Quality Crisis
o Payout Problems
• Conclusions
Introduction: The Middle 50% Offer Better Opportunities
In our last paper, The Dividend Deception: Understanding the Consequences of Cash Returns, we analyzed the highest dividend paying stocks in great detail. The conclusions were not encouraging: We found that firms in the top quartile of yield are hitting record high valuations which has driven their dividend yields to near record lows. Equally disconcerting, balance sheet quality and ROEs of high dividend payers are near record lows while margins and payout ratios are near record highs. For these reasons we suggest clients use a great deal of care when selecting names from the top quartile of dividend payers. We believe that the “bubble” among the highest dividend stocks gives active managers who operate with a dividend mandate a significant opportunity to drive risk-adjusted returns through careful stock selection.
Our clients’ reactions to our last dividend paper were mixed: the work seemed to confirm the views of some investors while others had a hard time believing that the perceived “safe haven” of the highest dividend payers could actually be a treacherous place to invest money now. A number of clients asked us how we thought they should find reasonable dividend income with lower risk. These queries led to this follow up paper in which we analyze the middle 50% of dividend payers to determine if this is a safer place to seek dividend yield. As usual, we will also see how successfully our Core Models can generate outperformance within the middle 50% of dividend payers. As you will see, we find the middle 50% of dividend payers to be a much more attractive pool from which to fish than the top quartile. We also find that our Core Models can add significant outperformance within either of these dividend yield groups.
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Finally, we believe that the growth of passive ETFs and index funds that have developed around univariate factors like dividend yield may be largely culpable for the “bubble” in the top quartile of dividend payers that we documented in our prior paper. We think over time that this distortion creates a fertile work-space for active managers, as PMs and analysts should find it easier to parse winners from losers within the group. If the recent past is any precedent, we may find that the payoffs to accurate stock selection in the space will be more dramatic as well.
To highlight this point, we gathered assets under management (AUM) data for five of the larger passive dividend-focused funds shown in Fig. 1. Ten years ago these funds managed negligible assets or were not in existence. Today they manage almost $60 billion with assets having exploded in the last 4 years. While the market’s broader thirst for yield has definitely been a contributing factor to the significant increase in valuations within the highest quartile of dividend payers, we feel that these products which focus only on dividends and that indiscriminately purchase yield have furthered the distortion. We understand that these funds could continue to gather assets at a rapid rate, temporarily sustaining or furthering these historically high valuations, but this is not a bet that we would be willing to make. With relative performance deteriorating we believe inflows may have peaked and the time is ripe for more coherent, fundamentally based stock selection.
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January 10, 2014 |
| Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin
January 10, 2014
Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin
