Dividend yield, does it matter?

1. Dividend yield, does it matter? Based on Fast Forward case.

2. What is risk premia? • P(t)=Div(t+1)/(r-g)=Div(t) (1+g)/(r-g) • P(t+1)=Div(t+2)/(r-g)=P(t)*(1+g) • Thus, Exp. Returns = DivY *(1+g) +g • Risk premia = DivY *(1+g) +g –Rf • But g Rf => Risk premia  DivY *(1+ Rf)

3. Another argument: valuation ratios shold be within some bound • Conventional efficient market theory: prices are random walk. • Thus, neither D/P nor P/E ratios should not have any forecasting power. • But if we will accept that for whatever reason DivY should be within some bound, then either numerator or denominator should move in a way that makes market variables forecastable. Then what moves?

4. Long-term Mean DivY=4.65%

6. Till next mean crossing...(a bit of cheating...) • Poor job for Div growth forecasting, R2=0.25% • Good job for price growth forecasting R2>30% • Thus, it is DENOMINATOR that brings back DivY within ”decent” range

7. One year horizon • Div growth is fairly predictable, R2=13% • Price changes are almost not predictable, R2 is about 1%

8. Ten years Horizon • R2=1% for DivG and 16% for PriceG. • Note that DivG results are not really explainable within eff. Mkt theory at all. • Based on that, within next 10 yrs we should expect 55% drop in S&P

9. P/MA10(E)

10. R2 for price growth regression is high (40%) Superior to DivY Forecast is really bad.. Forecasting from P/smoothed E ratio

11. We cannot forecast productivity growth....

12. Anything new happened within the last 30 years? Share buybacks • Share repurchases have tax advantages w.r.t. paying simple dividends. • Part of earnings that can be used for dividend payout is now smaller and DivY is underestimated w.r.t. similar number 50 years ago • What difference does it make?

13. Cole, Helwege & Laster,FAJ 96 Assuming both buybacks and new issues are done at market prices, significant adjustment for DivY is necessary

14. Adjustment of 0.8% in 96. Problem: most of options are issued at below mkt price. Liang and Sharpe: for 144 S&P500 firms in 97 adjustment is 1.39%, in 98 0.75% Cole, Helwege & Laster,FAJ 96 (2)

15. Hard assets and financial claims diverge

16. Intangible investmenst (1) • ”New economy” involves substantial investments in intangibles. • Accounting procedures do count activity to promote web site as expenses but ”...they are really investments”. Hall (2000) called it e-capital. • McGrattan &Prescott : understatement in earnings are about 26%

17. Intangible investmenst • McGrattan &Prescott : • understatement in earnings are about 26% • Fits only last couple of years • Bond & Cummins: if intangibles are counted as R&D and marketing, then for 459 industrial firms 82-98 still there is no explanation of overvaluation.

18. Demographic changes • Affluent society is formed • Baby boomers are educated, have money to invest and need to save for retirement (uncertainties related to Social Securities, etc. ) • Thus, one-time shift in risk premium.

19. Inflation • Responce to inflation is not always rational. Modigliani & Cohn 79: People discount dividends not at real, but at nominal rate. Thus, when inflation is high, stock market is undervalued, and when it is low, stock mkt is overvalued. • Now CPI is low...

20. International Evidence: Mixed

21. What else Dividends can tell us? • Let us consider 2 variables: Prices and dividends. • Gordon/Shapiro says, that • P(t)=E(k D(t+k) *(1+r)-k)P*(t) • P*(t)=P(t)+e(t), assume E(e(t)| P(t))=0 • =>cov(P,P*)=cov(P,P)+cov(P, e)=var(P) • -1<Cov(P,P*)/(StdPStdP*)<1 • => Std(P)/Std(P*)<1=> std(P)<Std(P*) • Volatility of forecast (prices) should be smaller than volatility of payouts (dividends). But the relationship is exactly opposite!!!!