Value investors question question

draz

Do you prefer a high earnings yield or a high dividend yield? And why?

yospaghetti

EDIT: Answered the wrong question. Thought you said "dividends or reinvested in the business" type question. Unffff, I need coffee.

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Edited 1 time(s). Last edit at Thursday, May 5, 2011 at 08:22AM by supersadface.

Kapie

They're not mutually exclusive, but if you're asking "high earnings yield but low dividend yield" vs "low earnings yield but high dividend yield" then the tie breaker is ROIC.

If ROIC is high and sustainable, I'd prefer high earnings yield but low div. yield.

Dapper425

Unless it's a REIT (or some other structure where earnings and dividend are substantially the same), then dividend yield is irrelevant, per M&M. Profitability (here, proxied by earnings) is important.

strikethree

My value credentials are nothing special, but in general, earnings yield trumps dividend yield, unless you suspect substantial earnings manipulation (in which case the dividend yield has the advantage of actually being paid). Ultimately it's the earnings power of the company that matters (and how that compares to business and financial risk). Whether it's paid now as a dividend or held for later as retained earnings matters, but is typically a second-order issue.

In a recession, however, dividend-paying companies are often seen as better able to withstand revenue contractions, because dividend payers are generally more mature, almost utility-like companies, and the dividend might be seen as an extra "cushion" before assets actually get eroded. Basically, dividends may be an indicator of lower risk. Given two companies with the same earnings yield, the one with the higher dividend yield is probably safer. This doesn't consider the opportunities of growth from reinvestment of retained earnings, but in a recession, growth is generally more difficult to achieve.



Edited 1 time(s). Last edit at Thursday, May 5, 2011 at 10:32AM by bchadwick.

BC_MBA_student

Thanks AF buddies. My question basically arose after reading The Little Book That Beats the Market which espouses the Earnings Yield (specifically EBIT / Enterprise Value) as the key metric. However, another line of thinking that I was reading states that if you dissect long run returns to equities, then it is the dividend yield that is crucial because you receive hard cash. I'm trying to figure out a set of screens. I'm conscious that earnings yield as stated is pre-tax and debt distortions which is helpful in creating a level playing field. But cash is cash is cash. And paying cash keeps companies honest, sorta. Realise that I need to do more reading into this and may be losing sight of something basic, but thought I would throw it out there.

soverby

I seem to recall that that book looks for high ROA (efficient business), and then a low valuation multiple (cheap), and then maybe a little bit of momentum (protect against a value trap).

Actually, maybe I don't remember the book very well, but I definitely remember the ROA aspect (though maybe it was the very similar EBIT/EV that you quote).

I remember wanting to run screens after reading that book, but got distracted by other things.

badonkus

> dividend yield that is crucial because you receive hard cash

1. that doesn't make any sense -- you can always convert retained earnings into "hard cash" by selling shares. this is simply a synthetic dividend.

> if you dissect long run returns to equities

2. there's a study which demonstrates that some large fraction of total shareholder return is composed of dividend payments. Be careful here. People regularly twist this finding into the conclusion "higher dividend payers produce greater TSR" -- wish I had a nickel for every time I've seen this on AF. I assume you can see the fault here.

> may be losing sight of something basic

3. Dividends are valued by one clientele: old retail investors. It's not a stretch to believe that they're not the sharpest investors. You can probably convince yourself why they like dividends.

4. Institutional investors, per a 2000s-era survey, dislike dividends (compared to share repurchase).

5. If you're a taxpayer, then you should dislike dividends. (We're currently in a temporary situation where the dividend tax penalty is diminished, but that's one one part of the general tax problem with dividends.)


Companies pay dividends because their peers pay dividends. Economically dividends don't benefit shareholders.

YAhmed

Dividends also suggest that there are no major growth opportunities justified at the company's WACC. So if it is believable that the company can't really grow profits at WACC or above, then it makes sense to pay dividends (or share repurchases, which are more efficient for taxable investors).

The key idea here is that if a company is retaining earnings, but doesn't have sufficient ROE, then that's a sign that capital is being destroyed.

ryanlb

Mudda

I read this book some time ago (so correct me if am wrong), but one thing that struck me as odd about this "magic formula" was that you had to hold stocks for one year (or just over one year to benefit from LTCG) and then sell regardless of performance. So, you are essentially turning your entire portfolio every year. I found this to be kind of counterintuitive to the value investing philosophy.