The Factors Driving Dividend Policy

By Laurence Booth

For income investors, specifically those seeking dividend income, it is important to invest in companies that are likely to sustain and boost their dividend payments moving forward. A cut in or elimination of a dividend not only takes away from income, but more than likely also results in a stock price decline, which further hurts their overall investment performance. Therefore, understanding why companies pay and raise dividends is important.

The article The Factors Driving Dividend Policy reviews the research of Laurence Booth and Jun Zhou, which they presented in “Dividend Policy: A Selective Review of Results From Around the World.” The two analyzed corporate dividend policies from around the globe and identified multiple factors that drive a company’s willingness (and ability) to pay and raise dividends.

These factors include:

• Communicating information, aka “signaling”
• So-called “agency costs,” the costs that companies face for paying a dividend versus investing back in itself
• Tax policy
• A company’s maturation

By understanding what drives a company to pay and increase its dividend, you can do a better job of selecting stocks of companies that are more likely to keep paying and increasing their dividends. The article The Factors Driving Dividend Policy will help you with that understanding.

As an organization, AAII does not advocate market timing. It takes a lot of savvy to identify market tops and bottoms correctly. As a result, there is too much risk of selling too early or buying too late in the face of a possible market downturn or recovery. However, it is useful to identify when the market as a whole is becoming too expensive, or too cheap, and make tactical investment decisions to benefit potentially from these market conditions.

The article Timing Indicators: The Bond-Stock Yield discusses how you can use the spread between bond yields and common stock yields to identify whether stocks are relatively overvalued, undervalued or fairly valued based on historical averages. Contrary to the article’s title, this approach isn’t intended to time the market. Instead, you can use this strategy to identify the valuation of stocks and, if needed, plan accordingly.

Specifically, the article discusses:

• The bond-stock yield spread and what information it conveys
• How to calculate the bond-yield spread
• The range of bond and stock yields over time

Lastly, the article looks at the current level of the bond-stock yield and what that could mean for the valuation level of stocks.

Knowing whether stocks are over- or undervalued relative to historical levels allows you to make portfolio allocation decisions to take advantage of the current level of valuations. Timing Indicators: The Bond-Stock Yield discusses one means of valuing the market as a whole to make those planning decisions.

The U.S. economy has been in a constant bull market cycle for the past 10 years. The recent occurrences in the economy have prompted changes in outlook moving toward a correction/financial crisis. Speculators believe that the next one is soon upon us and could have a global impact. The latest weekly survey asked our readers how long they think it will be before the U.S. economy slides into recession. The follow up question asks what they think will be the primary cause of the next recession.