Thursday, January 19, 2012

Earnings versus Dividend Yields

Given the good Bank of America earnings announcement today, I thought it is fitting to look at the earnings yield versus dividend yield of the S&P over a 50 year stretch of time. The ratio has been growing for a long, long while. Back in the 1960s, companies paid out a lot more of their earnings in dividends. Even given the rising trend, the ratio seems over-extended at this point. We have pretty high earnings yield at 7.7% but only a 2.1% dividend yield. The ratio seems to fall whenever we have some recession or slowdown, indicating that dividend cuts may lag earning declines. Assuming that earnings yield at least hold the line (a big IF), the long term trend suggests an overall dividend yield of 2.57%.

A more telling picture is this one below that plots earnings, dividend, and 10-year treasury yields all on the same axis. Notice that around the time of the dotcom crash, earning yields and bond yields started diverging whereas they pretty much mirrored each other for the many decades before, though the path that earnings took was a much rougher ride. Movements in dividends also generally mirror that of 10-year yields. So we have both dividends and 10-year notes disagreeing with earnings at this point. There may be many possible explanations for this behavior. Market prices have largely moved in line with earnings, but dividends seem to have followed at a much slower pace (though plenty of companies raised their dividends last year). Boards and management are approaching the rise in earnings quite cautiously, being quite reticent with respect to dividends. I suppose the cut in financial dividends (financials being the traditional high yielders) also contributed to this present state of affairs. The question remains, can both corporate leadership and the bond market be wrong while the stock market be right?

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