The First Cut: S&P 500 Stocks With High Payout Ratios & Below-Average P/Es
by John Bajkowski
Common sense would dictate that companies with high dividend payout ratios (dividends divided by earnings) would exhibit slower subsequent earnings growth than companies that retain the majority of their earnings to fund future growth. However, a study of S&P 500 stocks going back to 1871 by Robert Arnott and Clifford Asness observed the exact opposite: Over the modern era of their study (1946 to 2001), stocks with the lowest payout ratios (bottom 25%) exhibited an inflation-adjusted negative earnings growth rate of 0.4% over 10 years, while the companies with the highest 25% of payout ratios saw an average real annual growth rate of 4.2%. The authors suggest that managers of companies with high payout ratios may have confidence in their earnings and tend to be much more selective in their capital investments. For low or no payout ratio firms, managers may be wasteful with their cash.
The stocks that made this issues First Cut are S&P 500 stocks with a current payout ratio in the top 25% of S&P 500 stocks. The seven-year average payout ratio provides a historical company perspective, while the dividend yield reveals the current dividend level relative to the stock price. Nearly one quarter of S&P 500 stocks pay no dividends, and stocks with payout ratios of 40% or higher made our first cut. High payout ratios can foretell a cut in dividends, a concern in our current economic environment. The First Cut screen also looked for companies with consensus earnings estimates for the current year equal to or better than the last fiscal year as well as companies that have increased their dividend over the last five years. The growth rates in the table provide a feel for past and expected growth.
The study focused on payout ratios and subsequent earnings growth; the stock performance of the high payout ratio portfolios was not examined. As a simple valuation test, the final First Cut filter required that a firms current price-earning ratio be less than its five-year average. The 52-week relative strength index highlights the performance of these stocks relative to the S&P 500 index.