Focus on dividends – Single factor models not enough for dividend strategies, argues DWS

Most of equity investors’ total returns will probably continue coming from yield and growth of dividends, but they risk losing out if they make investment decisions on single-factor models, or invest passively, according to analysis by DWS Investments.

The German fund manager, headed by Wolfgang Matis (pictured) argues a multi-factor model, going beyond the capital asset pricing model, is better suited to assess opportunities and risks in dividend strategies.

A single factor model could “completely neglect plenty of companies that offer good dividend yields and growth potential,” it says.

“Historically, companies that pay high dividends have generally not offered great growth potential, and vice versa. But today, as we are faced with a bipolar world and severe structural challenges, there appear to be plenty of stocks that offer both.”

The CAPM model developed in the 1960s suggests, among other things, that the cross-section of expected excess returns of financial assets is necessarily linearly related to the market betas.

But DWS noted in a paper last November – Dividends: The case for income oriented investors – that more recent research on long-term dividend strategies using US shares (S&P 500 index), showed “while high dividend stocks have outperformed their lower yielding counterparts, the highest yielding stocks have not been the overall leaders in terms of total returns”.

Simplistically using only one factor, in isolation, therefore risks missing the best opportunities in the dividend world. 

Over the years 1980-2006, deciles eight and nine actually outperformed the tenth deciles, the highest yielding deciles. 

DWS explains further: “In addition, within the higher dividend yield universe, [the research] found a direct correlation between low payout ratios and higher returns.” 

The researchers created three dividend yield baskets; high yield, low yield and no yield, and within each basket further categorized stocks based on their payout ratio – again, high, medium and low. 

When equally-weighted portfolios of these baskets were created based on dividend yields and payout ratios, the best returns came from the basket combining the highest yields with low payout ratios – making 19.2% annualised compared to just 11.2 % from the market portfolio. 


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