As we discussed in our last post, dividend-paying value stocks have provided the smallest value premium compared to other measurements of value stocks. Today, we'll look at how turnover and diversification factor into a high-dividend strategy.
As I've mentioned before, strategies have no costs, but implementing them does. That's why we need to consider turnover.
Again using market cap to construct the data, the table below shows the percentage of value stocks by the various measuring factors that remain value stocks the following year.
% Remaining in Group
We have one more consideration to help determine the best value strategy.
Diversification The various rankings produce a widely different number of stocks in the value category. Because so few stocks now pay dividends, the dividend strategy limits the number of stocks that can be held in the portfolio. This not only reduces the benefits of diversification, but it can also negatively impacting trading costs. (Larger trade sizes can create market impact costs.) For example, ranking by BtM produced an average of 1,214 stocks. This compares to just 530 when ranking by D/P. Ranking by E/P and C/P produced 984 and 1,162, respectively.
Summary First, a high-dividend strategy is really a value strategy. Second, the historical evidence (at least in the U.S.) is that a high-dividend strategy not only produces the lowest premium, but it's not even a statistically significant premium.
If you want to gain exposure to the value premium, the "all four" strategy has produced the largest premium, but it also produces dramatically higher turnover, which reduces returns. Thus, the data suggests that the most efficient way to access the value premium is to sort by BtM.