by Teh Hooi Ling, Senior correspondent
Saturday, Feb 4, 2012
The Business Times Weekend
SHOW ME THE MONEY
Key article highlights:
Key article highlights:
- Strategy of buying baskets of stocks with varying ratios of dividend (D) yield to price-to-book (PTB) ratio was tested.
- The test data included list of stocks trading on Singapore Exchange every year on March 31 starting from 1990, dividend yield, price-to-book ratio and last traded stock price on Jan 17, 2012.
- Stocks were ranked based on dividend yield over price-to-book ratio (i.e. D/PTB ratio) and divided into 10 groups of equal numbers.
- Decile 1 comprised stocks with lowest dividend yield but highest PTB ratios; and Decile 10 comprised stocks with highest dividend yield but lowest PTB ratios.
- Quality of assets and corporate debt levels were not screened.
- There were 10 groups of stocks each year with their returns tracked annually.
- For each group, the median price appreciation was taken as the return and median dividend yield added to compute the total return respectively.
- The groups of stocks will be different each year depending on their D/PTB ratio as at Mar 31.
- 10 investors started 1990 with $100 were assumed with Investor 1 always investing in Decile 1 portfolio and Investor 10 in Decile 10.
- Each group's total return at the end of each year was reinvested in the following year's corresponding decile for 22 years.
- The result: Buying stocks with the highest dividend yield, but lowest PTB ratio appeared to be a winning strategy.
- The D/PTB strategy turned $100 into $1,575 for Decile 10, representing a compounded annual return of 13.3 per cent.
- Conversely, $100 diminished to just $16 for Decile 1, representing a decline of 7.9 per cent yearly.
- Meanwhile, the Straits Times Index's (STI) capital appreciation over the same period was 3 per cent annually excluding dividends.
- The D/PTB ratio strategy was then compared with the strategy of simply buying stocks with the lowest PTB ratios.
- PTB as a predictor of a company’s future stock performance was first highlighted by US finance professors Eugene Fama and Kenneth French in 1992.
- Their breakdown study showed convincing that the lower the company's ratio of PTB value, the higher its subsequent stock performance tended to be.
- Fama and French found that no other measure had nearly as much predictive power – not earnings growth, price/earnings, or volatility.
- The D/PTB test methodology was repeated by grouping stocks based on their PTB where Decile 1 comprised stocks with the highest PTB and Decile 10 with the lowest PTB.
- The result: Buying stocks with the lowest PTB outperformed the rest of the baskets of stocks but paled in comparison with that of buying stocks with the highest D/PTB ratios.
- The PTB strategy grew $100 into $365 for Decile 10, representing a compounded annual growth of 6.1 per cent.
- When a 3 per cent annual dividend yield was assumed for the STI constituent stocks, the PTB Decile 10 return was comparable to that of the STI's.
- Comparing the two strategies, portfolios of high D/PTB stocks fall less than the general market during downturns because the dividends provided a floor for the stocks' prices.
- Additionally, the performance of the highest D/PTB porfolio towered over the rest and appeared to have captured the market's absolute cream of the crop.
- Based on the two strategies' test results, screening stocks based on both dividends and PTB would yield a better outcome than selecting stocks just on PTB.