We have been writing a great deal recently about long term return expectations for the capital markets. The upshot of which is that given where yields are, both dividend and bond, we should not expect a return to an earlier era of double digit returns.
One reason why dividend yields are so paltry is that payout ratios, that is the percentage of earnings paid out in dividends, is historically low. The flip side of that is that companies are holding onto a big slug of cash at the moment. Witness Apple’s $81 billion of cash on the balance sheet. The question is whether all of that collective cash will be well used by corporate America.
Ironically a low payout ratio does not necessarily bode well for future earnings growth. From Buttonwood’s notebook:
A low payout ratio means that companies can use the retained cash to invest and grow future earnings (and thus dividends). It would be a good argument if there were evidence to support it. But the data point to the contrary conclusion. A paper by Cliff Asness (of AQR, the hedge fund) and Robert Arnott (former editor of the Financial Analysts’ Journal) shows that companies with a high dividend payout ratio produce higher future earnings growth than those with a low ratio.
They go on to note that by other measures like the Shiller P/E ratio the market remains overvalued. Another big fan of the Shiller measure is Jack Bogle who in an interview with Christine Benz of Morningstar lauded the Shiller P/E ratio. Bogle states:
I like the Shiller P/E. I like the Shiller P/E for two reasons: One, it’s focused on a longer period of time, not just on the moment, and that’s very important thing to do because earnings can do all kinds of things in short periods.
The challenge for investors is that even if they think the market is overvalued there are few viable alternatives. Mark Hulbert at Marketwatch notes that other times with similar Shiller measures at least investors could retreat to bonds. Hulbert writes:
In none of the intervening 140 years has Shiller’s version of the price/earnings ratio been as high as it is now when the bond market offered such low expected returns. The absence of a good alternative to stocks that Tint refers to is historically unprecedented…
Nevertheless, Tint concludes, “It’s hard to imagine that this decade won’t be a disappointing one, not just for stocks but for all asset classes.”
Not that the past decade has been all that great. Eddy Elfenbein at Crossing Wall Street points out this dim reality:
Twenty-four years ago today, the Dow lost 508 points. Since then, we’ve gained 9,839 points but only 80 have come since December 31, 1999.
No one knows what the next decade will bring. But the math, especially in regards to real bond yields, is tough to overcome. Higher dividend payout ratios are one thing that could help the longer term case for equities.
Here is the Jack Bogle interview in its entirety:
Items mentioned above:
Dividend yields, payout ratios and the Q-ratio. (Buttonwood)
Apple’s cash hoard. (AppleInsider)
Bogle: Market about fairly valued today. (Morningstar)
A recipe for stock market volatility. (Marketwatch)
24 years ago today. (Crossing Wall Street)
[earlier] Low yields and diminished return expectations. (Abnormal Returns)
[earlier] Setting return expectations. (Abnormal Returns)