The following is in response to Geoff Considine’s article,Do Income-Oriented Portfolios Reduce Safe Withdrawal Rates?, which appeared last week:
Dear Editor,
I am writing in regard to the article by Geoff Considine.
The author starts from the position …"It is easier to estimate the future return for a stock with a 4% yield than for one with no dividend." He based that assumption on work that analyzed the earnings of dividend-paying companies and found they were more consistent than those of zero-dividend stocks.
But that is a different issue from consistent stock returns.
Another paper looked at stock returns and dividend yields and found that (exhibit 7):
- Zero dividend stocks had the highest volatility.
- The comparative volatility did not decrease as dividend yields increased.
- The lowest volatility was found in the second lowest yield quintile.
- The return/risk of that quintile was higher than that for the largest yielders.
I would argue that portfolios not managed with a dividend focus will end up with yields pretty close to the index average – about in that second lowest yield quintile.
Leslie Reed
British Columbia, Canada
Geoff Considine replies:
You are correct that investing purely on the basis of dividends, without controlling for risk, will likely result in riskier portfolios. After all, an indiscriminate approach of buying the highest-yield stocks means that you will be buying a lot of firms in distress that have experienced big price declines but have not yet cut their dividends. This is what your second reference is showing.
On the other hand, if you control for risk, then you are reducing the problem to one of estimation risk rather than having a bias towards riskier firms when you select based on dividend yield. Based on the Gordon equation for the components on expected return, it is easier to estimate the dividend component of returns than the price appreciation component, which is made up of earnings growth rates and changes in P/E. Your second reference bolsters my argument rather than detracting from it.
