Payout Yield Research Articles

Litigation Risk Management Through Corporate Payout Policy

AbstractFirms modify their payout policy in anticipation of future litigation costs. We examine a comprehensive sample of U.S. corporate lawsuits and find that firms facing significant litigation risk pay lower dividends, and in some cases omit dividends while distributing more cash through share repurchases. Litigation risk changes the distribution of payouts but not the total payout yield as the increase in share repurchases offsets the decrease in dividends. Cash-poor firms cut share repurchases when settlement costs are incurred. The results suggest that firms at a higher risk of litigation increase their payout flexibility.

Machine learning portfolio allocation

We find economically and statistically significant gains when using machine learning for portfolio allocation between the market index and risk-free asset. Optimal portfolio rules for time-varying expected returns and volatility are implemented with two Random Forest models. One model is employed in forecasting monthly excess returns with macroeconomic factors including payout yields. The second is used to estimate the prevailing volatility. Reward-risk timing with machine learning provides substantial improvements over the buy-and-hold in utility, risk-adjusted returns, and maximum drawdowns. This paper presents a unifying framework for machine learning applied to both return- and volatility-timing.

Machine Learning Portfolio Allocation

We find economically and statistically significant gains when using machine learning for portfolio allocation between the market index and risk-free asset. Optimal portfolio rules for time-varying expected returns and volatility are implemented with two Random Forest models. One model is employed in forecasting monthly excess returns with macroeconomic factors including payout yields. The second is used to estimate the prevailing volatility. Reward-risk timing with machine learning provides substantial improvements over the buy-and-hold in utility, risk-adjusted returns, and maximum drawdowns. This paper presents a unifying framework for machine learning applied to both return- and volatility-timing.

The Conservative Formula: Quantitative Investing Made Easy

The authors propose a conservative investment formula that selects 100 stocks based on three criteria: low return volatility, high net payout yield, and strong price momentum. They show that this simple formula gives investors full and efficient exposure to the most important factor premiums and thus effectively summarizes half a century of empirical asset pricing research in one easy to implement investment strategy. With a compounded annual return of 15.1% since 1929, the conservative formula outperforms the market by a wide margin. It reduces downside risk and shows a positive return over every decade. The formula is also strong in European, Japanese, and emerging stock markets, and it beats a wide range of other strategies based on combinations of size, value, quality, and momentum. The formula is designed to be a practically useful tool for a broad range of investors and addresses academic concerns about p-hacking by using three simple criteria that do not even require accounting data.

Payout Yields and Stock Return Predictability: How Important Is the Measure of Cash Flow?

Payout Yields and Stock Return Predictability: How Important Is the Measure of Cash Flow?

The Conservative Formula: Quantitative Investing Made Easy

We propose a conservative investment formula which selects 100 stocks based on three criteria: low return volatility, high net payout yield, and strong price momentum. We show that this simple formula gives investors full and efficient exposure to the most important factor premiums, and thus effectively summarizes half a century of empirical asset pricing research into one easy to implement investment strategy. With a compounded annual return of 15.1 percent since 1929, the conservative formula outperforms the market by a wide margin. It reduces downside risk and shows a positive return over every decade. The formula is also strong in European, Japanese and Emerging stock markets, and beats a wide range of other strategies based on size, value, quality, and momentum combinations. The formula is designed to be a practically useful tool for a broad range of investors and addresses academic concerns about ‘p-hacking’ by using three simple criteria, which do not even require accounting data.

Market Capitalization, Corporate Payouts, and Expected Returns

This paper examines the present value framework that links market capitalization to non-dividend cash flows (i.e., share repurchases and issuances) beyond the conventional price–dividend relationship. We show that total (dividend plus non-dividend) cash flows can account for a large fraction of both price and return variations by using tests of cross-equation restrictions on vector autoregression (VAR), impulse response functions, and variance decomposition of unexpected returns. These results come from the fact that total cash flow shocks exhibit a strong negative correlation with payout yield shocks. Non-dividend cash flows help to reconcile our findings with previous literature that prices move substantially relative to dividends.

Predictors and Portfolios Over the Life Cycle

We show that the net corporate payout yield predicts both the stock market index and house prices and that the log home rent-price ratio predicts both house prices and labor income growth. We incorporate the predictability in a rich life-cycle model of household decisions involving consumption of both perishable goods and housing services, stochastic and unspanned labor income, stochastic house prices, home renting and owning, stock investments, and portfolio constraints. We find that households can significantly improve their welfare by optimally conditioning decisions on the predictors. For a modestly risk-averse agent with a 35-year working period and a 15-year retirement period, the present value of the higher average life-time consumption amounts to roughly $179,000 (assuming both an initial wealth and an initial annual income of $20,000), and the certainty equivalent gain is around 5.5% of total wealth (financial wealth plus human capital). Furthermore, every cohort of agents in our model would have benefited from applying predictor-conditional strategies along the realized time series over our 1960-2010 data period.

Payout Yields and Stock Return Predictability: How Important Is the Measure of Cash Flow?

We compare the stock return forecasting performance of alternative payout yields. The net payout yield produces more accurate forecasts relative to alternatives, including the traditional dividend yield. This remains true even after excluding several years during the Great Depression when issuance was unusually high. The measure of cash flow used to form the yield matters economically. Long-term investors’ hedging demand for stock is considerably reduced when net payout, rather than dividends, serves as the cash-flow measure. An agent relying on an incorrect payout measure is willing to pay an economically significant “management fee” to switch to the optimal policy.

Net Payout Yields and the Cross-Section of International Stock Returns

Net Payout Yields and the Cross-Section of International Stock Returns

Optimal Purchasing of Deferred Income Annuities When Payout Yields are Mean-Reverting*

We determine the optimal lifecycle purchasing strategy for deferred income annuities (DIAs)—which are distinct from single-premium income annuities (SPIAs)—for an individual who wishes to maximize the expected utility of his/her annuity income at a fixed time in the future. In contrast to the vast portfolio-choice literature for SPIAs, we focus on the stochasticity of the DIA’s payout yield and address concerns that rates are currently “too low” to justify irreversible annuitization. We assume a mean-reverting model for payout yields and show that a risk-neutral consumer who wishes to maximize his/her expected retirement income should wait until yields reach a threshold—which lies above historical averages—and then purchase the DIA in one lump sum. In contrast, a risk-averse consumer who is concerned the payout yield will remain below average for an extended period and worries about losing mortality credits while waiting, should employ a barrier purchasing strategy, as in the portfolio choice problem under transaction costs. We illustrate how this insight is applied in the context of annuitization. In fact, the optimal behavior of a risk-averse consumer resembles an asymmetric dollar-cost averaging strategy, with a portion of the DIA-budget spent even while payout rates are below historical averages. As part of our analysis we offer an easy-to-use asymptotic approximation for the optimal purchasing strategy (threshold) and provide some numerical examples to illustrate the concept.

Predictors and Portfolios Over the Life Cycle

We show that the net corporate payout yield predicts both the stock market index and house prices and that the log home rent-price ratio predicts both house prices and labor income growth. We incorporate the predictability in a rich life-cycle model of household decisions involving consumption of both perishable goods and housing services, stochastic and unspanned labor income, stochastic house prices, home renting and owning, stock investments, and portfolio constraints. We find that households can significantly improve their welfare by optimally conditioning decisions on the predictors. For a modestly risk-averse agent with a 35-year working period and a 15-year retirement period, the present value of the higher average life-time consumption amounts to roughly $179,000 (assuming both an initial wealth and an initial annual income of $20,000), and the certainty equivalent gain is around 5.5% of total wealth (financial wealth plus human capital). Furthermore, every cohort of agents in our model would have benefited from applying predictor-conditional strategies along the realized time series over our 1960-2010 data period.

Net payout yields and the cross-section of international stock returns

The positive relation between the firm’s net payout yield (NPY) and subsequent stock returns, previously found in the United States, is similarly present in foreign international equity markets. That is, firms with high net payout yields significantly outperform firms with low net payout yields. The observed return effect is robust to common controls, such as firm size, book-to-market and momentum, as well as to recently proposed controls for investment and operating profitability. Consistent with the changing payout behavior of firms around the world, the net payout yield holds more cross-sectional information for predicting subsequent stock returns than the traditional dividend yield.

Optimal Purchasing of Deferred Income Annuities When Payout Yields are Mean-Reverting

Optimal Purchasing of Deferred Income Annuities When Payout Yields are Mean-Reverting

Sequential Learning, Predictability, and Optimal Portfolio Returns

ABSTRACTThis paper finds statistically and economically significant out‐of‐sample portfolio benefits for an investor who uses models of return predictability when forming optimal portfolios. Investors must account for estimation risk, and incorporate an ensemble of important features, including time‐varying volatility, and time‐varying expected returns driven by payout yield measures that include share repurchase and issuance. Prior research documents a lack of benefits to return predictability, and our results suggest that this is largely due to omitting time‐varying volatility and estimation risk. We also document the sequential process of investors learning about parameters, state variables, and models as new data arrive.

Net Cash Disbursements to Equity Holders: Implications for Stock Return Predictability and Long-Horizon Consumption and Portfolio Decisions

We compare the stock return forecasting performance of alternative payout yields. The net payout yield produces more accurate forecasts relative to alternatives, including the traditional dividend yield. This remains true even after excluding several years during the Great Depression when issuance was unusually high. The measure of cash flow used to form the yield matters economically. Long-term investors' hedging demand for stock is considerably reduced when net payout, rather than dividends, serves as the cash flow measure. An agent relying on an incorrect payout measure is willing to pay an economically significant `management fee' to switch to the optimal policy.

Net Cash Disbursements to Equity Holders: Implications for Stock Return Predictability and Long-Horizon Consumption and Portfolio Decisions

Dividends represent only one facet of cash flows between firms and shareholders. This paper compares the forecasting power of alternative financial ratios for stock returns and cash flow growth. We focus on the predictive content of issuance activity, both separately and when incorporated within a net payout yield. Inference is sensitive to the sample period examined, due to extraordinary stock issuance around the Great Depression. Post-Great Depression, we find little evidence that the issuance yield forecasts stock returns, but strong evidence that this yield forecasts future issuance growth. The net payout yield forecasts both stock returns and growth in net payout. The evidence is ambiguous regarding whether the net payout yield provides more accurate return forecasts relative to the total payout yield or dividend yield. We show that the particular choice of yield matters economically in the context of long-horizon consumption and portfolio decisions.

Payout yield, risk, and mispricing: A Bayesian analysis

We develop a simple parametric model in which hypotheses about predictability, mispricing, and the risk-return tradeoff can be evaluated simultaneously, while allowing for time variation in both risk and expected return. Most of the return predictability based on aggregate payout yield is unrelated to market risk. We consider a range of Bayesian prior beliefs about the risk-return tradeoff and the extent to which predictability is driven by mispricing. The impact of these beliefs on an investor's certainty-equivalent return when choosing between a market index and riskless T-bills is economically significant, in both ex ante and out-of-sample analyses.

Has the Propensity to Pay Out Declined?

AbstractRecent studies document both a significant decline in firms’ propensity to pay dividends and a significant increase in firms’ propensity to repurchase shares and issue equity over the past 30 years. In this paper we test whether firms’ net cash disbursements to equity holders have declined in a pattern similar to firms’ propensity to pay dividends. Contrary to the evidence using dividends, we find no evidence that the conditional propensity to distribute net cash to equity holders has declined over the past 3 decades. Surprisingly, we find that, conditional on firm characteristics, net payout yields have been increasing over time.

Common Divisors, Payout Persistence, and Return Predictability

ABSTRACTIn the finance and accounting literature, the use of a common divisor in the dependent and independent variables of ordinary least‐squares regressions is commonplace. What goes less recognized, however, is that their use induces spurious correlation between the regression variables and invalidates standard testing procedures. This paper analyses the common divisor problem by outlining analytical results concerning the expected R2 and providing a simulation procedure that generates test statistics from which critical values can be drawn. To illustrate the procedure, we re‐investigate payout yield return predictability findings that have appeared in the literature and show that the results are spurious.