Studying yield-based investment strategies, the authors conduct a comparative analysis and find that a yield metric that includes dividends, net repurchases, and net-debt pay down earns the highest historical compound annual growth rate and provides the highest three-factor alpha estimates.
In a study of yield-based investment strategies, the authors include four yield measures: dividend yield (DIV), dividend plus repurchase yield (PAY1), dividend plus net repurchase yield (PAY2), and shareholder yield (SHYD). They identify net-debt pay down as a way to create a more inclusive shareholder yield metric that enhances the returns to yield-based investment strategies.
How Is This Research Useful to Practitioners?
Looking at dividend yield is one way to predict returns. But dividend yields by themselves tend to be poor predictors of returns, so it is important to explore other ways of predicting returns and enhancing yield-based investment strategies.
The authors study the four yield measures mentioned earlier (DIV, PAY1, PAY2, and SHYD). PAY1 includes dividends plus repurchases. PAY2 includes dividends plus net repurchases. SHYD includes net-debt pay down as part of the yield calculation. They conduct a comparative analysis of yield-based strategies to identify the strategy that is most beneficial for investors.
The authors construct yield measures using common dividends, share repurchase and issuance data, firm size, and debt reduction data as inputs. Through equal-weighted portfolio construction, they show that dividend yield alone does not have significant alpha. Adding repurchases to dividends creates statistically significant three-factor alpha. Adding net repurchases to dividends improves the three-factor alpha even more. Finally, the authors conclude that adding net-debt pay down to the yield metric has the highest significant three-factor alpha and the highest average monthly returns.
How Did the Authors Conduct This Research?
With the exception of REITs, American Depositary Receipts, closed-end funds, and some financial firms, data used include all firms on the NYSE, Amex, and NASDAQ with required data on CRSP and Compustat. Stock returns are measured from 1 July 1972 through 31 December 2011. Market capitalization is calculated by using the 30 June value of any given year. Yield measures are calculated with equal-weighted portfolio construction.
DIV is calculated as the ratio of common dividends to market capitalization. PAY1 is the ratio of common dividends plus repurchase cash flow to market capitalization. PAY2 is the ratio of common dividends plus repurchase cash flow minus equity issuances to market capitalization. SHYD is calculated as the ratio of debt reduction plus repurchase cash flow plus common dividends minus equity issuances to market capitalization.
The authors show that high-yield strategies have historically performed better than low-yield strategies and among the high-yield strategies, strategies based on SHYD perform the best in terms of compound annual growth rate and provide the highest Fama–French three-factor alphas.
Through comparative analysis of yield-based investment strategies, the authors conclude that a yield metric that includes dividends, net repurchases, and net-debt pay down enhances the returns to yield-based investment strategies and provides the highest three-factor alpha estimates. This study is an important addition to the literature on yield-based investment strategies in times of declining dividend payments.