Yes, yes and a hundred more times YES!
It’s said that scientific theory advances one death at a time and something similar could be said about finance. I’ve ranted before about how wrong the Capital Asset Pricing Model is [CAPM – The Cost of Constraints] and the paper I’m highlighting this week is another brick in an impressive and now incontrovertible wall of academic research that highlights how important dividends are.
There is still a church, with a sizable congregation, that prays to work done in 1961 by Messieurs Miller and Modigliani that says dividends don’t matter. Their work is intuitive (which is probably why it survives?) and says the value of a firm won’t be impacted by whether a company retains profits, buys back stock or pays a dividend; ultimately M+M argue it’s all the same. Well, here’s the update, it’s not.
When I analyze a company my interest in dividends is threefold; first, they tell me something about the strength of the business and the attitude of management to shareholders. Second, they tell me the management of the enterprise understand capital discipline. Finally, they are an important component of any calculation of potential long-term return. [A plug here for Mr. David Webb’s excellent Webb-Site where, for free, you can get total return charts for all Hong Kong listed stocks. Charts for Chinese banks for example with and without dividends included are quite materially different over time.]
However, there’s another dimension to why dividends matter. Sigitas Karpavičius from the University of Adelade and Fan Yu from Fudan University have analyzed the US stock market from 1975 to 2102 and established the value of dividend paying firms exceeds those of non-dividend paying firms by between 5.3% and 27.9% (depending on how you do the calculations). Along the way they reference other work that shows the value of a firm that initiates a dividend is 7.5%, 15.6% and 24.% higher after 1, 3, and 5-years. They also note value spikes for dividend paying firms in both 2002 and 2008 when the stock marked declined by 23% and 39% respectively highlighting how, in tough times, dividend payers reward investors.
They also took a look at whether stock buybacks affect firm value. They don’t; unless they’re very big. In fact, they actually undermine firm value. This may be because of the long term effect they have on dividend paying ability? Worth bearing in mind next time you or I meet a company doing piddly buy backs and telling us it’s to shareholders’ advantage?
Finally, the authors note the value of a firm increases in direct proportion to the size of the dividend payout. Enough said.
Happy Sunday.
[You can access the paper in full at Are Dividend Paying Stock Worth More?]