Does Higher Dividend Payout = Higher Earnings Growth?

by: Margin of Safety Investing

Today I am adding to my recent articles on dividends (I like dividends! and Surprise higher dividend payout = higher earnings growth), as I finally found the research by Zhou and Ruland: called “Dividend payout and future earnings

I first read this article back in 2006 when it came out in the Financial Analyst Journal; its implications are pretty profound and counterintuitive to a lot of people/investors.

When talking about dividends, the conventional wisdom goes something along the lines of: “If a company is paying dividends, it’s is a signal that they don’t have enough growth opportunity to fund hence their future growth is going to be sub-par". But I believe this argument is flawed as proved by Zhou and Ruland’s research:

High-dividend-payout companies tend to experience strong, not weak, future earnings growth. These results are robust to alternative measures of payout and earnings, sample composition, mean reversion in earnings, the effects of particular industries, time periods, and share repurchases.

Another interesting “collateral” finding of the study is that repurchases are also related to future earnings growth but the relationship is stronger for dividends.

What explains the positive relationship between current payout and future earnings growth?

Zhou and Ruland further analyze their data to support the findings of the “free cash flow theory” which suggests that the managers of companies with abundant free cash flows have incentives to overinvest. Thus, the low dividend–low growth relationship may be a result of overinvestment on the part of low-payout companies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.