The authors begin by noting that the percentage of firms paying a dividend has declined from 63 percent in 1972 to 36 percent in 2011. They also cited the 2001 study, "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?", by economist Eugene Fama and finance professor Ken French that found that even after controlling for firm characteristics, firms have become less likely to pay dividends.
One reason for the disappearing dividends is that firms have increasingly substituted share buybacks for dividends. The authors of a 2002 paper found that "Repurchases have not only become an important form of payout for U.S. corporations, but also that firms finance their share repurchases with funds that otherwise would have been used to increase dividends." They concluded: "Firms have gradually substituted repurchases for dividends."
To address the problem of the disappearing dividends, Gray and Vogel examined four metrics to see if they had predictive value:
- Dividends (DIV)
- Dividends plus repurchases (PAY1)
- Dividends plus net repurchases (repurchases minus equity issuance) (PAY2)
- Dividends plus net repurchases plus net debt paydown (SH/YD)
The data covers the period 1971-2011 and the largest 2,000 stocks. The following is a summary of their findings:
- Controlling for exposures to the market, size, value, and momentum factors, DIV and PAY1 strategies have no alpha (excess return) after controlling for either the three- or four-factor models -- they don't generate statistically reliable excess risk-adjusted returns.
- Regardless of the yield metric, the predictive power of separating stocks into high- and low-yield portfolios has lost considerable power in the last 20 years. In the latter half of the sample, from 1992 through 2011, DIV loses any forecasting ability it might have had in the previous time period.
- Splitting a yield category by payout percentage doesn't improve risk-adjusted performance -- firms with higher payout ratios don't earn higher risk-adjusted returns.
Interestingly, while the authors didn't find that buying high-yielding stocks is a good "bet," they did find that buying low-yielding securities is a poor risk-adjusted bet. They also found that the other metrics contained information -- PAY2 and SH/YD provided economically and statistically significant alphas. Using these metrics, the lowest-yielding quintile stocks produced statistically significant negative alphas, and the highest-yielding ones produced statistically significant positive alphas.
The dividends plus net repurchases plus net debt paydown metric-- SH/YD -- produced the most robust results over the full period. The authors concluded, "Our evidence corroborates what previous authors have concluded: Dividend yield is no longer an effective metric to predict future returns. We also find evidence that more holistic metrics of yield have stood the test of time, but even their predictive ability has fallen."
Gray and Vogel's findings contribute to the literature that demonstrates that dividend strategies are neither good substitutes for safe income nor a reliable way to generate market-beating returns.