By Mark Hulbert
Many on Wall Street argue the dividend yield has lost much or all of the value it used to have as a valuation indicator. But I disagree.
The case against the dividend yield is well-known and, on its surface, compelling.
Prior to the early 1990s, for example, the stock market’s yield rarely dropped below 3%, and an investor would have done well by getting out of stocks whenever the yield declined toward that threshold. Over the past three decades, however, the dividend yield has hardly ever been above 3%; the only exceptions came over a few months near the bottom of the 2008-2009 bear market.
So any market timer following the pre-1990s rule would have missed out on one of the most favorable periods for U.S. equities.
The conventional explanation for the dividend yield’s declining utility places the blame squarely on stock buybacks. Companies have increasingly turned to repurchases to return cash to shareholders, according to this argument. As a result, dividends simply don’t play the role that they once did.
The accompanying chart, below, certainly appears to provide empirical support to this narrative. It plots the S&P 500’s buyback yield, which represents the total repurchases of S&P 500 companies as a percentage of the index. This yield has grown markedly since the late 1990s, and over the past 20 years it’s been rare for it not to exceed the dividend yield.
The S&P 500’s total shareholder yield reflects the sum of both its dividend and its buyback yields. And it appears to have potential as a better valuation indicator than the simply dividend yield. Notice from the chart, for example, that over the past two decades the shareholder yield has almost exclusively stayed above the 3% threshold.
Rising to the defense of the dividend yield
There are at least two major reasons not to give up on the dividend yield.
The first: The decline in the dividend yield to previously-unheard-of levels was not due to repurchases. That is the finding of a study published a number of years ago in the Journal of Financial Economics by Eugene Fama (the 2013 Nobel laureate in economics) and Ken French, a Dartmouth finance professor.
They found that a major cause of the declining dividend yield was the marked increase in the number of small firms that are barely profitable or downright unprofitable — firms that are unable to pay a dividend, in other words. Since most stock repurchases are made by companies that also pay dividends, “repurchases turn out to be rather unimportant” in explaining the declining dividend yield.
The other reason not to dismiss the dividend yield too quickly: Whatever other shortcomings it may have, it continues to have greater predictive power than either buyback yield or total shareholder yield.
To show this, consider the track records I calculated for each of these three yields since 1998, which is when the buyback yield started to become substantial. The table below reports a statistic known as the r-squared, which reflects the degree to which one of these three yields explains or predicts the S&P 500’s /zigman2/quotes/210599714/realtime SPX -1.18% subsequent real total return. Notice that the dividend yield’s r-squared is higher than the other two yields, regardless of the time horizon of its prediction.
|Yield since 1998||R-squared at the 1-year horizon||R-squared at the 5-year horizon||R-squared at the 10-year horizon|
|Total shareholder yield||1%||30%||49%|
The bottom line? There are two.
First, reports of the dividend yield indicator’s death are greatly exaggerated.
The second, which follows from the first: You shouldn’t dismiss the bearish message of that yield. Using a simple econometric model based on data since 1871, the current dividend yield translates to an expected 10-year real total return for the S&P 500 of only 3.0%.
Status of valuation indicators
I also want to report the latest values of the eight indicators I report each month in this space, my monthly review of the status of valuation indicators with the best record predicting the stock market’s 10-year returns. As you can see, it’s not just the dividend yield that is painting a sobering picture about the stock market’s longer-term prospects.
|Latest||End of last month||Beginning of year||Percentile since 2000 (100 most bearish)||Percentile since 1970 (100 most bearish)||Percentile since 1950 (100 most bearish)|
|Buffett ratio (Market cap/GDP )||2.08||1.97||1.82||100%||100%||100%|
|Average household equity allocation||50.9%||50.9%||47.6%||99%||99%||99%|
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com .