Monday, 22 October 2012

The problem with dividends

I'm a fan of dividends. I trust them more than earnings which I feel can be more easily manipulated. So what's the problem? Well, the problem with using dividend yields as a valuation method is that different countries/industries/sectors have different cultures and taxation regimes when it comes to paying out dividends and the importance those investors place on dividend yields. 


In general dividend payouts as a percentage of earnings are much higher in the UK and Europe compared to the USA and most of Asia.


A bird in the hand...

As the saying goes "A bird in the hand is worth two in the bush" and when it comes to retained earnings I'm generally of the same opinion. The existence and credibility of retained earnings and their value to investors as increased future earnings is suspect. I agree they should carry some weight however. If we discount retained earnings by 50% we can get an adjusted yield of:

Adjusted Yield = Dividend Yield + [(Earnings Yield - Dividend Yield) / 2 ]

Where: Earnings Yield = 1 / P/E Ratio

The following chart gives the estimated Adjusted Yields of iShares funds. The green being the actual dividend yield and the blue being the discounted retained earnings. (P/E ratio used in the calculations is an average of data available from, and yahoo finance; September 2012) 


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