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 (Surprise! Higher Dividends = Higher Earnings Growth, Financial Analysts Journal, 2003) observed the exact opposite.

The authors suggested that managers of companies with high payout ratios may have confidence in the stability and growth of their earnings and tend to be much more selective in their capital investments. For low or no payout ratio firms, managers may retain too much of their firm’s earnings because of a desire to build up empires and subsequently use their cash hoard in a wasteful fashion.

The 20 stocks that made this issue’s First Cut are among those with the current highest payout ratios in the S&P 500 index. The seven-year average payout ratio provides a historical company perspective.

While more than 80% of S&P 500 member companies pay a dividend, just 187 pay out at least 40% of their earnings as dividends. Since a high payout ratio can signal an inability to grow or maintain the dividend, we required the passing stocks to meet two additional criteria. First, the indicated dividend must be above the dividend paid for the most recently completed fiscal year. Secondly, the I/B/E/S consensus earnings estimate must signal earnings growth for the current fiscal year. Real estate investment trusts (REITs) were also excluded since they pay distributions instead of qualified dividends.

Finally, a price-earnings ratio below the average for the last five years was required to identify those stocks that may be undervalued on a relative basis.