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:::: Here’s what the dividend yield is really telling us about stocks ::::
By Mark Hulbert | May 9, 2017

Bullish signs show up in a long-bearish indicator

Might the U.S. stock market’s dividend yield — when properly understood — be sending a bullish signal right now?

That would definitely come as a surprise, since most investors consider the dividend yield to be hopelessly irrelevant and outdated. It’s been at least two decades since analysts stopped looking to the dividend yield for insight into the overall market’s valuation.

Yet an entirely different picture emerges if we look at the total amount that companies are returning to shareholders—a total that includes both dividends and share repurchases (or buybacks). Up until several decades ago, dividends were the predominant way in which companies returned cash to shareholders, so up until then the dividend yield was a good approximation of shareholder yield (also known as payout yield).

Since then, however, the dividend yield has become less of a good proxy for payout yield, since companies have increasingly turned to buybacks as a way of returning cash to shareholders. In order to focus on payout yield, therefore, it has become crucial to include both dividends and net buybacks in the calculations.


Consider the last quarter of 2016, which is the most recent quarter for which S&P Dow Jones Indices has data. The S&P 500’s SPX, +0.00% buyback yield (based on net buybacks during the quarter) came in at 2.79%--larger than the S&P 500’s dividend yield of 2.06%. Taken together, that meant that the S&P 500’s net payout yield stood at 4.85%. (See chart below.)



To put that in context, consider that the dividend yield averaged 4.73% during the prior decades in which dividends were the primary way in which companies returned cash to shareholders. (This average is based on data back to 1871 from Yale University’s Robert Shiller, and extends up to 1998, which is when the accompanying chart begins.)

In other words, the S&P 500’s recent shareholder yield is slightly above what used to be the long-term average for the dividend yield. While that doesn’t constitute an outright buy signal, it paints a far more optimistic picture than the screaming sell signal that the dividend yield itself has been issuing for the last two decades.

For confirmation of this surprising conclusion, I turn to the newsletter I track that uses dividend yield as a stock selection tool: Investment Quality Trends, edited by Kelley Wright. The newsletter is in first place for risk-adjusted performance over the past 30 years, according to my performance tracking.

Wright’s newsletter has maintained a database for more than 50 years which reflects the relative proportion of dividend-paying stocks are that under- or overvalued. The database contains several hundred dividend payers that have sound balance sheets and a long history of paying dividends. It then is broken down into four categories:

· The “Undervalued” category contains stocks whose dividend yields are close to the high ends of their historical ranges;

· The “Overvalued” category contains stocks whose yields are close to the low ends of their ranges

· The “Rising Trend” category includes stocks whose prices have risen enough to move them out of the “Undervalued” category but not far enough to achieve “Overvalued” status;

· The “Declining Trend” group is the opposite of the “Rising Trend” category.

It turns out that the stock market’s subsequent return has tended to be higher when the proportion of stocks in the Undervalued and Rising Trend categories have been larger—and lower when most stocks are in the other two categories.

Currently, 58.1% of the stocks tracked by Investment Quality Trends are in both the Undervalued and Rising Trend categories. While that is slightly below the comparable average of 59.3% since 1966, the current percentage is far higher than the readings below 30% that were registered in the weeks approaching the top of the internet bubble in early 2000 and the top of the bull market in October 2007.

Of course, other valuation indicators besides the dividend yield suggest that the U.S. stock market is overvalued. So the relatively bullish message of the total payout yield does not mean that all the potential clouds on the horizon have disappeared.

But the job of a contrarian is to challenge assumptions that are so widely held that they go unquestioned. The unquestionably bearish message of the dividend yield is one of those assumptions. If you’ve been out of stocks because of it, you may want to reconsider.

http://www.marketwatch.com/story/heres-what-the-dividend-yield-is-really-telling-us-about-stocks-2017-05-09

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