•     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.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra
for anyone seeking out more information related to the topics above.


The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

January 10, 2014 |

Categories: White Papers

January 10, 2014

Categories: White Papers

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