Markus Rosgen, a Citigroup Inc. equity strategist in Hong Kong, has turned the commonly used metric of dividend yield on its head with interesting results.
The inverse of dividend yield is, of course, the price of a share divided by its most recent payout.
The measure can be thought of as a dividend-payback period, with a 5% yield implying a 20-year horizon for return of capital to the investor discounting any gain or loss from a change in the stock price.
“The concept is simple,” Rosgen says. “Assuming no increase in the payout ratio, no rise in dividends, how long will it take investors to get the current outlay back in the form of dividends?”
Well, the answer is almost 73 years for the MSCI India index, which makes the third biggest Asian economy “the most expensive market in the region,” Rosgen and his colleagues, Elaine Chu and Brian Li, said in a report this week.
When the outlook for capital appreciation is clouded—as it is now, by high food and fuel prices, a global credit crunch and dinner-table talk of stagflation—it’s quite natural that investors will look for stocks that have more assured payoffs.
That was a key insight of a 1991 study, titled The Equity Yield Curve by Richard Bernstein, Merrill Lynch and Co.’s chief US strategist, and Bernard Tew, a fund manager who now works for New York Life Investment Management.
“In an uncertain economic environment, most investors would rather own a short payback asset,” the Citigroup researchers say, identifying Pakistan (16 years) and Taiwan (22 years) as more attractive than not only India, but also South Korea (54 years) and China (39 years).
‘Generation too far’
The inverse of the payout yield is a crude measure because it supposes that a company’s cash flows won’t change in the future, an assumption that holds for mature enterprises in developed economies, but not for their fast growing rivals.
Even so, a payback period that’s too long could be an important clue that prices are unsustainable. “India with a 113-year payback in January 2008 was just a generation too far for most investors,” say Rosgen and his colleagues.
Sure enough, the benchmark Bombay Stock Exchange Sensitive Index, or Sensex, has declined 30% this year in US dollar terms, the fourth-worst performer in Asia after Vietnam, China and the Philippines.
So far this year, foreign investors have sold a net $5.5 billion in Indian equities, spooked by a surge in inflation.
Another way to view the dividend-payback period is to think of it as a rough-and-ready stock market equivalent of what fixed-income investors know as “duration,” or the sensitivity of a bond price to interest rates. (One important caveat: Bernstein’s research found little correlation between dividend yields and sensitivity of stocks to interest rates.)
While duration is a standard tool in the bond researcher’s kit, measuring the sensitivity of equity prices to rate changes is “more recent,” David Blitzer, chairman of the index committee at Standard and Poor’s in New York, said in a 2004 paper he co-wrote with his colleague Srikant Dash.
The literature on equity duration goes back less than 25 years “and its use in investment management is far from widespread,” Blitzer and Dash said.
The S&P analysts calculated the equity duration for the US stock market and found that it had reached a 15-year high a little before the Federal Reserve began raising interest rates in mid-1999. Everyone knows that US stocks collapsed because the dot-com bubble burst. But the high vulnerability of equity prices to the rising cost of capital may also have played a role. S&P analysis showed that was the case during that time.
Subsequent reductions in borrowing costs didn’t help, the S&P analysts said, because the equity duration, or sensitivity of stock prices to interest rates, also slumped to a 10-year low.
The S&P 500 lost 49% of its value from March 2000 to October 2002. That episode may provide a lesson for investors in India, where the cost of capital is rising.
The Indian central bank increased its benchmark interest rate by a quarter percentage point last week to 8%, which compares with 6% three years ago. With inflation at its fastest in seven years, Indian interest rates may have to climb still higher.
If Indian equities are at present vulnerable to interest rates because of their duration, then the chances of a drop in the index are high. Credit Suisse Group’s forecast is for the Sensex to fall to 13,000 by the end of this year, a further 16% decline from the current level.
Another relevant example may be of Taiwan, which, like India, had a dividend-payback period in excess of 100 years: in 1997 and in 2000.
It seemed that investors would wait for two or three generations to get their money back. That show of patience proved to be ephemeral and Taiwanese companies had to increase their payout ratios, Rosgen and his colleagues noted in a research note they wrote in January.
Indian firms may have to do the same as investors prod them for a money-back guarantee—in this life.
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