Current Research K: Dividend Slices

Updated: February 25, 2008
Graphs Added: September 26, 2008

Current Research Index

Dividend Slices

I have constructed Dividend Slices A calculator using Professor Kenneth French’s D+P (dividend plus price) annual data (1928-2006). I used my Gummy 03A01 calculator as a starting point. This version is in my Dividend Slices Folder in my Yahoo Briefcase.

Kenneth R. French Data Library
Yahoo Briefcase

Dividend Slices: Initial Investigation

I determined annual returns at Years 10, 20 and 30 for four major dividend slices using Professor Kenneth French’s database. I calculated regression equations in terms of the percentage earnings yield 100E10/P.

Here are some of my findings.

Valuations (as measured by 100E10/P) influence all of the slices almost identically except for the Equally weighted Slice A, which consists of companies that pay no dividends.

Among dividend paying companies (slices B, C and D), the regression lines are nearly parallel. To an excellent approximation, companies with higher dividend payments have higher returns. That is, slice D is consistently better than slice C, which is consistently better than slice B.

Value weighted Slices A (no dividends) and B (lower 30% of dividend payers) have similar returns. Valuations have a minimal effect on Equally weighted Slice A.

Comparing R-squared levels, the effect of valuations is strongest at Year 20. It is stronger with Value weighting than with Equal weighting.

Comparing R-squared levels, the effect of valuations is stronger at Year 10 than at Year 30.

Dividend Slices: Initial Investigation
Dividend Slices Graphs

Dividend Slices: Typical Returns

I calculated the returns of dividend slices B and D for today’s valuations (P/E10=28) and at typical valuations (P/E10=14).

This attaches some numbers to our traditional knowledge about the advantage of selecting high dividend stocks.

Dividend Slices: Typical Returns

Switching with Dividend Payers

I conducted a brief optimization of switching with Value D and Equal D stock portfolios. I determined the best P/E10 thresholds and stock allocations subject to Benjamin Graham’s constraint that both stock and bond allocations must be from 25% to 75%. I used TIPS with a 2% real interest rate for my non-stock investment.

Previously, with the S&P500 and its “Gummy Slices,” the optimal allocations had been 75%-40%-25% with P/E10 thresholds of 11 and 21, respectively. This time, a single threshold worked best [within any meaningful precision], with P/E10=17 in both cases. The optimal stock allocations were 75%-25%, below and above threshold, respectively. Both had a broad optimum.

I interpret this as a true result.

Apparently, it makes sense to hold a higher percentage of stocks at intermediate valuations when they make generous dividend payments. Value D and Equal D consist of the 30% of stocks with the highest dividend yields.

Value D stocks are weighted according to capitalization. This emphasizes larger stocks, similar to the S&P500. Equal D stocks are weighted equally. This emphasizes smaller stocks. Since both Value D and Equal D have the highest yielding 30% among dividend payers, both are traditional value stocks.

Value D corresponds closely to Large Capitalization Value stocks. Equal D corresponds roughly to Small Capitalization Value stocks.

I collected Year 30 Historical Surviving Withdrawal Rates for 1928-1980. The Value D regression equation is y=0.2694x+5.0841 plus 3 and minus 2, where x=100E10/P and y=the historical surviving withdrawal rate. R-squared is 0.1743. At today’s valuations (P/E10=28), y=6.05 plus 3 and minus 2. The Safe Withdrawal Rate is 4.05% of the original balance (plus inflation). The Most Likely rate (50%-50% chance of success) is 6.05%. The Almost Certain to Fail rate is 9.05%.

The Equal D regression equation is y=0.2153x+6.2495 plus 4 and minus 2. R-squared is 0.0996. At today’s valuations (P/E10=28), y=7.02% plus 4 and minus 2. The Safe Withdrawal Rate is 5.02% of the original balance (plus inflation). The Most Likely rate (50%-50% chance of success) is 7.05%. The Almost Certain to Fail rate is 11.02%.

In times of normal valuations (P/E10=14), Value D has a Safe Withdrawal Rate of 5.01% of the original balance (plus inflation). The Most Likely rate is 7.01%. The Almost Certain to Fail rate is 10.01%.

In times of normal valuations (P/E10=14), Equal D has a Safe Withdrawal Rate of 5.79% of the original balance (plus inflation). The Most Likely rate is 7.79%. The Almost Certain to Fail rate is 11.79%.

The variation of Safe Withdrawal Rates with valuations, although small, is enough for statistical significance (as opposed to having no effect).

Summary

With high dividend payers, the best switching algorithm is very close to using a 75% stock allocation when P/E10 is less than 17 and 25% when it is greater than 17.

Today’s Year 30 Safe Withdrawal Rate with Value D stocks (similar to Large Capitalization Value stocks with the highest yields) is 4.05%. If valuations were normal, the Year 30 Safe Withdrawal Rate would be 5.01%.

Today’s Year 30 Safe Withdrawal Rate with Equal D stocks (similar to Small Capitalization Value stocks with the highest yield and with equal dollar allocations) is 5.02%. If valuations were normal, the Year 30 Safe Withdrawal Rate would be 5.79%.

The optimal conditions were broad. Minor differences, looking forward, should have little effect.

More about Dividend Payers and Switching

I have determined optimal conditions for Slices A (no dividends) and B (lowest 30% among dividend payers). I based this on Year 30 Historical Surviving Withdrawal Rates.

The earlier conclusion remains: when sliced according to dividend yields, a single threshold does well.

More about Dividend Payers and Switching

Shun Rebalancing with Dividends

I collected data comparing portfolios with High Dividend stocks and stocks that pay no dividends. I used my Dividend Slices A calculator. The data source was Professor Kenneth French’s database.

I examined three portfolios. The first was Equally Weighted Dividend Slice A, which contains stocks that pay no dividends. The second was Equally Weighted Dividend Slice D, which contains the one-third of the stocks that pay the highest dividends. The third consisted of equal amounts of these two, rebalanced annually.

I looked at the real (inflation adjusted) total return of an initial $1000 investment. I made no deposits or withdrawals. I looked at 5, 10, 15 and 20 year sequences beginning in 1950-1980.

My conclusion: Buy the highest dividend stocks. That was the best. It beat all other combinations, including the attempt to gain an advantage from rebalancing.

I have placed my data in the Dividend Slices folder of my Yahoo Briefcase. Download my Rebal A Div Slices spreadsheet. My Yahoo username is jwr19452000.

Yahoo Briefcase
Shun Rebalancing