Differential returns on dividend and capital gains income, systematic abnormal returns surrounding ex-dividend dates, excess returns on small versus large capitalization stocks, excess returns on low versus high price-earnings ratio stocks—these are among the recent findings that cast doubt on the traditional Capital Asset Pricing Model and tease investors with the promise of systematic excess returns.
Some of these effects are undoubtedly related. Tests indicate, for example, that the higher a portfolio’s price to book ratio, the higher the corresponding values of market capitalization, P/E and stock price. Furthermore, P/E, dividend yield, price and P/E effects all experience significant January seasonals. What has not been conclusively determined is whether the effects are additive. So far, it appears that the dividend yield and size effects are not mutually exclusive. Investors may want to use a strategy employing several of these characteristics, rather than one.
Efforts to explain the size effect have focused on January, because the effect is concentrated in that month. The most common hypothesis attributes this to year-end tax-loss selling, but the evidence is less than conclusive. Evidence strongly suggests, however, that, among small firms, those with the largest abnormal returns tend to be the firms that have recently become small, that either don’t pay dividends or have higher dividend yields, and that have lower prices and low P/E ratios.