Swedroe: Are Dividends A Value Strategy?

June 02, 2014

It's worth re-examining whether high-dividend strategies really are good value strategies.

As I’ve previously discussed, the Federal Reserve’s zero-interest-rate policy has “pushed” many investors—especially those who use a cash-flow approach as opposed to a total-return approach—to look to stocks and equity funds that have a high dividend yield; that is, that have a low price-to-dividend ratio.

Adding to their attraction is that a high-dividend strategy has outperformed the market over the long term. And this has been true around the globe.

However, it’s long been known that a high-dividend strategy is basically a value strategy, one that correlates highly with value strategies such as buying stocks with low prices-to-book value, earnings, sales or cash flow. The question then is, Is a high-dividend strategy the best, or even a good, value strategy?

One problem with dividend-focused strategies is that because today only about one-third of stocks pay dividends, such a strategy is less diversified than strategies that screen for the other value factors.

In addition, they can lead to concentration in sectors such as utilities, creating other risks, such as term risk. And for taxable investors, dividends are less tax efficient than capital gains because you are taxed on the full amount of the dividend, instead of just the portion that is profit.

Despite these issues, the attraction of current income has led to a heightened interest in these strategies. With that in mind, Gregg Fisher decided to take a close look at whether the focus on high dividends actually added or subtracted from returns. His study, “Dividend Investing: A Value Tilt in Disguise?” appeared in the April 2013 edition of the Journal of Financial Planning.

Fisher’s study covered the 33-year period from August 1979 through July 2012. His objective was to determine which factors best explained stock returns. Using Barra’s performance-attribution methodology, various risk factors such as value, growth, momentum and company size were separated out to determine the contribution of each to the portfolio’s returns.

For the high-dividend strategy, he used the highest-yielding 10 percent of the Russell 3000 Index. The Russell 3000 was used to represent the market portfolio. The following is a summary of his findings:

The high-dividend-yield portfolio’s annualized return was 1.27 percentage points greater than that of the total market portfolio (12.42 percent versus 11.15 percent).

The high-dividend strategy had, as should be expected, a high loading on yield: 1.60. Other loadings of note were leverage (0.42), momentum (-0.22), growth (-0.41), value (0.53), volatility (-0.37) and earnings yield (-0.47).

By tilting the portfolio to high-dividend-paying stocks, investors were—perhaps unknowingly—tilting their portfolios to value stocks.

The factors with the largest contributions to the excess return of the high-dividend strategy were: earnings yield (2.28 percent), volatility (1.22 percent), value (0.41 percent) and growth (0.40 percent).


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