International evidence on stock returns and dividend growth predictability using dividend yields

Abstract

This paper examines stock returns and dividend growth predictability using dividend yields in seven developed markets: United States of America (US), United Kingdom (UK), Japan, France, Germany, Italy, and Spain. Altogether, these countries account for around 85% of the Morgan Stanley Capital International (MSCI) World Index. The use of the long time series with up-to-date data allows the comparison not only between countries, but also across periods, putting into perspective the existence or not of noticeable changes since the 1980’s. The majority of the literature on this topic is US-centered. This emphasis on the US is even more pronounced when it comes to examining the relationship between the dividend unpredictability and dividend smoothing. There is also the need to know if the relationships already documented for the post-Second World War (WWII) period still hold during the last three decades, when stock markets were subjected to a high level of turbulence worldwide. The relationship between dividend yields and returns and dividend growth is central to understand the functioning of capital markets, and has considerable implications for capital asset pricing and investment strategies. Overall, the results show that even for developed capital markets there is no clear pattern on the predictive ability of dividend yields on stock returns and dividend growth, instead these relationships seem to be time-dependent and country-specific. For each country, the predictive ability of the dividend yield is examined in a first-order structural VAR framework by applying bootstrap significance tests and the degree of dividend smoothing is assessed using four partial-adjustment models for the dividend behavior. Additionally, an out-of-sample analysis is conducted using pseudo-R2 and a normal mean squared prediction error (MSPE) adjusted statistic. For the post-WWII period, returns are predictable, but dividends are unpredictable in the US and the UK, while the opposite pattern is observed in Spain and Italy. In Germany, there is some evidence of short-term predictability for both returns and dividends, while in France only returns are predictable. In Japan, neither variable can be forecasted. The dividend smoothing results show that dividends are more persistent in the US and the UK, however, there is no clear connection between dividend smoothness and predictability for the other countries. An important conclusion to retain from the out-of-sample analysis is that the predictability of returns after the WWII, especially present in the US, appeared to have been missing in the last three decades, most probably due to the turmoil experienced by the stock markets during this last period.

Portfolio Selection Based on a Four-Dimensional Weighted Scoring Model

“…The approach to measure the pay-out of a company is to calculate its dividend yield. According to Monteiro, Sebastião and Silva (2020), stock returns can be strongly forecasted by dividend yield, which is verified by previous studies [11]. In addition, dividend yield precisely indicates the dividend that investors will benefit from per unit of asset since dividend yield is obtained by dividend per share of a stock divided by its one share price.…”

Does duration of competitive advantage drive long-term returns in the stock market?

“…We can divide this group of indicators into two subgroups: the first one includes the yield related indicators (earning yield, dividend yield, dividend plus buybacks yield, and implied cost of capital [ICC]) and the second includes the non-yield related indicators (price earnings ratio [PE] and book to market). The most popular among the first subgroup is the dividend yield (Fama & French 1988;Monteiro et al, 2020;Rozeff, 1984), while the most popular indicators among the second subgroup are the price-earnings ratio (Campbell & Shiller, 1988), the earnings-price ratio (Campbell & Shiller, 1998;Fama & French, 1989), the book-to-market ratio (BM) (Pontiff & Schall, 1998), and dividends and buybacks (Straehl & Ibbotson, 2017).…”