There was a fascinating article by Andrew Gluck in "Investment Advisor," the 3/02 issue, pp. 34-38: "Arnott Asks, Why Not?" Rob Arnott is the CEO of First Quadrant, a money management outfit. Mr. Arnott has been a prolific writer of financial papers and his company bio. indicates he's won the Association for Investment Management and Research Graham and Dodd Scroll four times. He seems to speak with authority on investment matters and recently offered some challenging (to conventional investment "wisdom") conclusions about risk premiums, retained earnings, and high dividend payout ratios.
Mr. Arnott's research leads him to believe that:
- While there is an equity risk premium (the likelihood of increased return for stocks over bonds due to the greater risk of the former), it is not 5%, as often thought, but around 2.5%;
- When dividend payout ratios are low and retained earnings high, it turns out that "the reinvestment gets sloppy and subsequent earnings growth becomes atrocious;"
- High dividend payout ratios usually correlate with relatively high earnings growth.
All in all, his research shows that, contrary to the "it's different this time" mentality of the 1990s, dividend yields for stocks do matter. In general, we ignore their importance to a stock's total return at our peril. Traditionally, equities have paid dividends, or yields, at about a 4% a year level. Given that the total return for stocks has been roughly 11% a year, this means that the growth, or capital appreciation, portion of an asset's return has been only about 64%, on average.
Further, as noted in item #2 above, overall if the dividend payout is low, so is the company's rate of growth. In a nutshell, company management does not make as good use of the extra money it controls, through providing no or low yields, as the shareholders would if they received it as significant dividend checks. Quite the reverse. If the top brass are sitting on large amounts of cash, as a rule it gets squandered in one way or another, from unwarranted benefits for the executives, at the expense of common stock shareholders, to poor investments in unrelated businesses, or to unprofitable expansions of existing endeavors, leading often to artificially inflated earnings, supported by unethical accounting practices, and so on.