A high dividend yield has long been a useful metric for value-minded investors. Since stock prices and dividend yields have an inverse relationship, all else equal, a high dividend yield can mean a depressed share price and represent a good buying opportunity.
The following chart showing the S&P 500's quarterly value and dividend yield illustrates this relationship:
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| Source: Standard & Poors (through 3/31/2013) |
Indeed, the correlation between the two data sets is -53.3%. Even with the significant dividend cuts during the financial crisis, dividend yield has remained a useful buying metric over this period.
What about buybacks?
Given the rise in buyback activity in recent decades, however, some in the investing community have suggested that we reduce the emphasis on dividend yield and focus more on a "total" or "adjusted" yield that also considers buybacks.
Using the same S&P data, here's how quarterly buyback yield alone compares to the S&P 500 quarterly market value:
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| Source: Standard & Poors |
As you can see, buyback yield has a much more positive correlation with equity values -- +60.4% by my calculation for this period. In other words, as stock prices have gone up, buyback yields have generally risen, too.
Even when we combine dividends and buybacks to come up with a "total" or "adjusted" yield, the relationship is still positive:
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| Source: Standard & Poors |
If anything, then, a higher total yield tends to suggest an over-valued market rather than the other way around.
Granted, this is a relatively small sample size of a few dozen quarters. Perhaps over the course of a few decades companies will begin to repurchase more of their stock when prices are depressed and make total yield more of a helpful indicator. Well...here's to hoping at least.
Bottom line
Though I'm certainly not against buybacks and think they should be included in any equity research process, investors should be skeptical about using a high total or adjusted yield as a buying signal.
Other good reads this week
- From the vault: Michael Mauboussin on measuring moats. (Very helpful tools for your research process)
- Abnormal Returns: There is No Such Thing as Emotionless Investing
- Reformed Broker: The World According to Investors
It is our belief that shareholders should demand of their managements either a normal payout of earnings -- on the order of, say, two-thirds -- or else a clear-cut demonstration that the reinvested profits have produced a satisfactory increase in per-share earnings. ~Benjamin Graham, The Intelligent Investor (ch. 19)
Have a great weekend!
Best,
Todd
@toddwenning on Twitter
