Future Dividend Growth Research Articles

Does sustainability improve financial performance? An analysis of Latin American oil and gas firms

The growing concern about environmental, social, and governance (ESG) issues raises questions about the presence of financial incentives that naturally offset —at least partially— the higher operating costs stemming from ESG-related investment policies in the oil and gas sector, which is characterized by its strong environmental impact. Building on Campbell and Shiller's present value decomposition and using an instrumental variables-based methodology to address measurement errors in ESG scores, in this paper we analyze the effects of corporate ESG performance on expected dividend growth and discount rates for oil and gas firms in Latin America (Latam). On the one hand, our results suggest that ESG policies developed by oil and gas firms in Latam are related to lower medium-term discount rates. On the other hand, ESG practices adopted by oil and gas companies are also related to lower future dividend growth. These findings suggest that the lower discount rates resulting from active ESG policies at least partially offset the costs derived from the green transition of the oil and gas sector in Latam, meaning that the efforts made by oil and gas companies to improve their ESG performance, together with public initiatives aimed at covering a portion of the costs derived from corporate ESG policies, can make some unexploitable oil reserves in Latam become viable.

The effects of economic policy uncertainty on stock market returns: Evidence from Brazil

This article investigates the effects of economic policy uncertainty on the Brazilian stock market. We link excess returns and dividend growth rates to the economic policy uncertainty index of Baker et al. (2016) and other control variables. In recent years, Brazil has experienced political tensions, which affected its economic policy. Therefore, this country is the most suitable environment to test the hypothesis that this measure of economic policy uncertainty has an informational content not wholly reflected in the usual constructs of economic uncertainty and economic distress. Our results show that economic policy uncertainty (i) correlates negatively with current excess stock returns; (ii) correlates positively with future excess stock returns, showing itself to be a good predictor of future performance of the stock market; (iii) is not significantly related to future dividend growth rates; and (iv) anticipates changes in discount rates.

Euro Stoxx 50 Dividends—Reconciling Analyst Estimates and Dividend Future Prices

The authors analyze the dynamics of analysts’ dividend estimates and dividend futures prices and combine them to decompose fluctuations in the equity market into fundamental expectations and discount rate adjustments. Although analysts tend to be overly optimistic about dividends paid over short horizons, the authors find analysts possess skill regarding the direction of future dividend growth. The authors provide evidence that prices of dividend futures are driven more by hedging activity than fundamental views or uncertainty around future cash flows, leading prices to drop significantly below analysts’ expectations and subsequent realized payoffs in times of increased equity market volatility. Looking at the outbreak of COVID-19 and the following Euro Stoxx 50 crash, they find that most of the drop in the equity index was attributable to discount rate adjustments, not fundamental views. Investors can use the methodology the authors present to formulate an alternative view on the drivers behind future market swings. TOPICS:Fundamental equity analysis, derivatives, futures and forward contracts, performance measurement, financial crises and financial market history Key Findings ▪ Consensus dividend estimates for European blue chips tend to be too optimistic during both market crashes and stable times. ▪ Prices of Euro Stoxx 50 dividend futures are affected by hedging activity related to their origin in structured equity products, causing prices to drop significantly below analysts’ expectations and subsequent realized payoffs when markets are volatile. ▪ Using both analyst estimates and the prices of dividend futures allows us to attribute a large fraction of the equity market crash during COVID-19 to discount rate adjustments rather than to changes in fundamental expectations.

Dividend Suspensions and Cash Flow Risk during the COVID-19 Pandemic

Firms suspended dividend payments in unprecedented numbers and at unparalleled speed in response to the outbreak of the COVID-19 pandemic. We develop a dynamic econometric model that allows dividend suspensions to affect the conditional mean, volatility, and jump probability of growth in daily dividends and demonstrate how the parameters of this model can be estimated using Bayesian Gibbs sampling methods. We find that dividend suspensions had a sharp and immediate impact on the conditional mean and volatility of daily dividend growth. Information embedded in daily dividend suspensions proves valuable in monitoring and predicting the trajectory of broader measures of economic activity during the pandemic.

How Predictable? Rent Growth and Returns in Sydney and Melbourne Housing Markets

We construct rent-price ratios for houses and units in 82 local government areas in the Sydney and Melbourne markets for the period 1985/86-2015. Using this annual data we employ long-horizon regression techniques and find that rent-price ratios (i.e. rental yields) have predictive content for both future real housing returns and future growth rates of real rents. However rents and returns have greater predictability in Sydney than in Melbourne. Using a variance decomposition for the rent-price ratio implied by the present-value model, we find that variation in rental yields of units in Sydney is almost fully accounted for by expected changes in future rent growth and returns. There appears to be no role for rational bubbles in influencing the prices of Sydney units. In contrast – on average – lesser portions of the variance in rental yields on houses in Sydney (two thirds) and Melbourne (one third) and units in Melbourne (60 percent) is explained by expected future returns and rents. Evidently there is scope for (stochastic) rational bubbles to have affected these markets. Our results point to an important difference between the behaviour of residential housing markets and stock markets. In the stock market, current changes in dividend-price ratios do not appear to reflect important variations in future dividend growth. Our results for Sydney and Melbourne suggest that current changes in rent-price ratios do signal future changes in rent growth.

A comparison of alternative models for estimating firm’s growth rate

The growth rate plays an important role in determining a firm’s asset and equity values, nevertheless the basic assumptions of the growth rate estimation model are less well understood. In this paper, we demonstrate that the model makes strong assumptions regarding the financing mix of the firm. In addition, we discuss various methods to estimate firms’ growth rate, including arithmetic average method, geometric average method, compound-sum method, continuous regression method, discrete regression method, and inferred method. We demonstrate that the arithmetic average method is very sensitive to extreme observations, and the regression methods yield similar but somewhat smaller estimates of the growth rate compared to the compound-sum method. Interestingly, the ex-post forecast shows that arithmetic average method (compound-sum method) yields the best (worst) performance with respect to estimating firm’s future dividend growth rate. Firm characteristics, like size, book-to-market ratio, and systematic risk, have significant influence on the forecast errors of dividend and sales growth rate estimation.

Momentum Effect as Part of a Market Equilibrium

AbstractDoes the momentum effect arise naturally from the determination of asset prices in market equilibrium? We calibrate a standard endowment model of multiple assets under recursive preferences. The momentum effect partly comes from investors’ aversion to consumption risks. An unexpected dividend increase generates a positive return and increases the asset’s proportion of consumption, raising the correlation between its future dividend growth and consumption growth. This is compensated by a higher expected return, generating the momentum effect. The cross-sectional difference in expected returns is also a key contributor. The quantified model produces sizable momentum profits, often close to the observed profits.

Dividend-Price Ratios and Stock Returns: International Evidence

A widely replicated result, using U.S. data, is that dividend-price ratios predict future returns, not future dividend growth. This is evidence of stock-return predictability, and is contrary to the original interpretation of the efficient-market hypothesis. The author argues that this pre-dictability may be an artifact of the American economy’s remarkably stable real growth. This article examines the relation between dividend yields, future returns, and dividend growth, using current international data. It concludes that, in some countries, dividend-price ratios predict future returns; in other countries, they predict future dividend growth; and in still other countries, they predict a combination of the two. The variation, furthermore, is related to the volatility of real dividend growth.

Expected Returns and Dividend Growth Rates Implied by Derivative Markets

The dividend-price ratio is a noisy proxy for expected returns when expected dividend growth is time-varying. This paper uses a new and forward-looking measure of dividend growth extracted from S&P 500 futures and options to correct the dividend-price ratio for changes in expected dividend growth. Over January 1994 through June 2011, dividend growth implied by derivative markets reliably forecasts future dividend growth, and the corrected dividend-price ratio predicts S&P 500 returns substantially better than the standard dividend-price ratio, in-sample and out-of-sample. Time-varying expected dividend growth is important to explain price movements, especially because it is highly correlated with expected returns.

Revisiting Dividend Growth Predictability via Dividend Yield

One of the main theoretical implications of the present value approach on firm valuation is the hypothesis that dividend yield has a predictive power on future dividend growth. The relevant literature, however, was not able to provide evidence that clearly supports this hypothesis. In this paper we cope with the two main reasons that raise the econometric complexity on testing the dividend growth predictability hypothesis, namely, the seasonality effects that appear when higher frequency data are used, and the effect of price volatility on the computation of dividend yield. Specifically, an application of a the Mixed Data Sampling (MiDaS) technique allows us to use monthly dividend data in order to test the hypothesis that dividend yield explains the future annual dividend growth. In order to cancel out the effects of price variation on dividend yield we use a smoothing technique, and we identify the component of the smoothed dividend yield that offers predictive power. Empirical evidence from US, UK, Canada, Germany, France and Japan, strongly supports the dividend growth predictability hypothesis.

Dividend-Price Ratios and Stock Returns: Another Look at the History

A critical question for investors is the extent to which the expected returns on common stock are predictable. One of the prime pieces of evidence supporting the hypothesis that returns are predictable is that regressions of future returns on dividend-price ratios are highly significant, but future dividend growth is unrelated to the ratio. This article presents an alternate interpretation of these regression results that is consistent with the original version of the efficient market hypothesis, which holds that expected returns are unpredictable. The analysis is based on the economic history of the United States. The historical analysis not only provides an alternative interpretation of the regression results, but also highlights the importance of analyzing the specific historical events responsible for generating financial data.

Dividend-Price Ratios and Stock Returns: International Evidence

A widely replicated result, using U.S. data, is that dividend-price ratios predict future returns, not future dividend growth. As noted by Cochrane (2011) in his Presidential Address to the American Finance Association, this is evidence of stock return predictability contrary to the original interpretation of the efficient market hypothesis. However, Cornell (2012) argues that the evident predictability may be an artifact of the remarkably stable real growth of the American economy. To further investigate this question, this paper examines the relation between dividend yields, future returns and dividend growth using current international data. It is found that in some countries, dividend-price ratios predict future returns, in other countries they predict future dividend growth, and in still other countries a combination of the two. These heterogeneous findings support the interpretation that the relations between the variables depend on historical circumstances.

Dividend-Price Ratios and Stock Returns: Another Look at the History

One of the prime pieces of evidence supporting the hypothesis that expected stock returns vary over time is that regressions of future returns on dividend-price ratios are highly significant, but future dividend growth is unrelated to the ratio. This paper presents another interpretation of these results that is consistent with constant expected returns based on the economic history of the United States. In so doing, the paper not only provides an alternative interpretation of the regression results, but also highlights the importance of analyzing the historical events responsible for generating financial economic data.

Predicting dividends in log-linear present value models

In a present value model, high dividend yields imply that either future dividend growth must be low, or future discount rates must be high, or both. While previous studies have largely focused on the predictability of future returns from dividend yields, dividend yields also strongly predict future dividends, and the predictability of dividend growth is much stronger than the predictability of returns at a one-year horizon. Inference from annual regressions over the 1927–2000 sample imputes over 85% of the variation of log dividend yields to variations in dividend growth. Point estimates of the predictability of both dividend growth and discount rates are stronger when the 1990–2000 decade is omitted.

Which Stocks are Inflation-Proof?

Returns from a zero-investment portfolio that is long in US firms whose dividends alter during a year, and short in firms whose dividends remain the same, produces positive returns in 52 of the 53 years between 1955 and 2007. These positive returns are related to expected inflation, which appears to contribute between 3 and 7 percentage points to the annual nominal return.We suggest that this is partly due to the signaling role of quarterly dividends. We argue that the greater the tendency of a company to smooth its dividends, the less likely are its shareholders to adjust their estimates of future nominal dividend growth in line with inflation. The more the company smooths its dividends, the greater the lag in incorporating current inflation into the dividend; and the less informative they are about future earnings. If dividend smoothing does affect the extent to which shareholders adjust their expectations in response to expected inflation, we would expect to see this effect show up in stock returns.We relate smoothing of annual dividends to smoothing of quarterly dividends, identifying extreme smoothers as those who pay four identical quarterly dividends in a 12-month period. We find no evidence that paying four such identical dividends is a signal of a firm in trouble; rather that such a policy reduces the informativeness of dividends about future earnings and growth. We also find no evidence that the extreme smoothers have unusual characteristics that would cause investors in these stocks to require from these stocks, ex ante, lower returns, or returns that are less responsive to inflation.

Stock Market Mispricing: Money Illusion or Resale Option?

AbstractWe examine two hypotheses to explain stock mispricing: i) the money illusion hypothesis (Modigliani and Cohn (1979)) and ii) the resale option hypothesis (Scheinkman and Xiong (2003)). We find that the money illusion hypothesis may explain the level, but not the volatility, of mispricing in the U.S. market. In contrast, the stock resale option hypothesis, which stems from heterogeneous beliefs about future dividend growth rates and short-sale constraints, can explain both the level and the volatility of mispricing. The evidence suggests that while the two hypotheses complement each other in explaining the level of mispricing, the resale option hypothesis provides a more coherent explanation for asset price bubbles, in which extraordinarily high price levels are often accompanied by excessive volatility and frenzied trading.

What Do Asset Price Movements in Germany Tell Monetary Policy Makers?

Asset prices can play a twofold role in monetary policy. First, they may be seen as important elements in the chain along which monetary policy stimuli are transmitted to the real economy. From this perspective, asset price movements cause changes in aggregate demand or the price level through substitution, income and wealth effects. If these structural relationships were stable and could be estimated reliably, asset prices could be used as indicators of, or even target variables for, monetary policy. Second, they may be seen as predictors of the future course of the economy, independently of their active role in the transmission process. This view does not depend on the causal influence of asset prices on the macroeconomic variables to be predicted. Instead, it takes due account of the fact that the price of rationally valued assets should reflect the expected path of the asset’s income components and the equilibrium returns used for discounting the future stream of income. If these expectations were influenced by the anticipated development of certain macroeconomic fundamental factors, and if, furthermore, market expectations were not systematically biased, asset prices could be used by the central bank as predictors of real activity and inflation. The monetary policy implications of both roles depend crucially on the informational efficiency of asset markets. Market inefficiencies would cause asset prices to deviate from their fundamental values, distorting their informational content and their indicator quality. Furthermore, if asset prices play an important role in the transmission process, mispricing may adversely affect economic activity and price stability. The main body of this paper is devoted to assessing the predictive power or the informational content, respectively, of dividend yields and the term structure spread to draw some preliminary conclusions about the efficiency of the stock and government bond markets in Germany. The theoretical framework is provided by the rational valuation approach. Applied to the bond market and the stock market, this approach leads to the expectations hypothesis and the dividend discount model, respectively, both on the assumption of rational expectations. The informational content is judged by metrics from univariate regression techniques using short and long-horizon measures for future inflation, stock returns, dividend growth, and interest rate changes as dependent variables and the spread or the dividend yield as regressors. The paper closes with some implications of the results for monetary policy.

Market fundamentals versus rational bubbles in stock prices: a Bayesian perspective

AbstractUsing Bayesian Markov chain Monte Carlo methods, we decompose the log price‐dividend ratio into a market fundamentals component and a bubble component. The market fundamentals component depends on expectations of future dividend growth and required returns, while the bubble component is assumed to follow a Markov switching model that allows for the possibility of exploding and collapsing regimes. If prior beliefs allow for the possibility of persistent shocks to dividend growth and/or required returns, the posterior distribution suggests the bubble component contributes virtually nothing to the stock price movements over our sample. On the other hand, if one's priors rule out the possibility of persistent shocks to dividend growth and required returns, the bubble component can have a much larger role to play in stock price movements. However, the regime switching behavior of the bubble bears little resemblance to infrequent switching from an exploding bubble regime to a collapsing or dormant bubble regime. Copyright © 2008 John Wiley & Sons, Ltd.

Expected Returns and Dividend Growth Rates Implied in Derivative Markets

The dividend-price ratio is a noisy proxy for expected returns when expected dividend growth is time-varying. This paper uses a new and forward-looking measure of dividend growth extracted from S&P 500 futures and options to correct the dividend-price ratio for changes in expected dividend growth. Over January 1994 through June 2011, dividend growth implied by derivative markets reliably forecast future dividend growth, and the corrected dividend-price ratio predicts S&P 500 returns substantially better than the standard dividend-price ratio, in-sample and out-of-sample. Time-varying expected dividend growth is important to explain price movements, especially because it is highly correlated with expected returns.

Characterizing the Co-Movement of the Stock and Bond Markets

This paper documents a negative relation between the volatility of the U.S. stock market and the covariance of the U.S. stock and bond markets when the stock market is highly volatile. Cash-flow effect, compared with risk-premium effect, contributes substantially to this relation. During a volatile period, a decrease in expected future dividend growth rates induces a considerable decline in the covariance and a significant increase in stock market uncertainty. However, this negative relation has been pronounced only in the last two decades, not in the 1960s and 1970s. The fact that the inflation rate is high and volatile during the first subperiod but stays low and stable in the second subperiod causes this different relation.