Increase in the Dividend Yield and the Samwick Effect

Is Meg Richards confused as to the fundamentals of finance:

With earnings growth on the decline, there’s renewed interest in what was once considered an old-fashioned investment. Dividends – regular payments to shareholders out of a company’s retained earnings – have long provided a boost to total return, and now analysts say they could help drive the stock market higher … Historically, dividends have played a much more important role than they currently do, accounting for about 4 percentage points of the roughly 10 percent average annual return stocks have delivered since 1926. But their popularity waned during the bull market … Why now, two years after the tax act was passed, are dividends taking the lead? It’s partly because earnings growth was so strong, it eclipsed the importance of the humble dividend

Mark Thoma tries to make sense of her article:

Why has the dividend payout ratio increased in recent years? According to the article below, there are several possible reasons: (1) Concerns about future returns. When investors expect the market rate of return to exceed the internal rate of return for the firm, they would prefer to have dividends paid out instead of reinvested internally. Thus, as investors anticipate lower rates of return in the future, they will shift towards firms offering dividends and away from firms that use profits for internal reinvestment. (2) The tax act of May 2003 made dividends relatively more attractive from a tax perspective. (3) A change in corporate compensation law has led to a restructuring towards compensation packages that rely more heavily on dividends. (4) There has been a recent shift by investors towards assets with less risk, and historically firms with both solid growth and yield characteristics have less risky overall returns.

Mark leads with the key issue of expected future earnings, which is why I raised the Samwick effect, which we mentioned here. Simply put – if expected future earnings growth is low, firms that wish to serve shareholder interest will increase the proportion of current earnings that are paid out to shareholders. While Mark seems to have a shorter term perspective, the Baker-DeLong-Krugman paper that Mankiw commented upon by in part drawing on the Samwick effect (which is a corollary of the Miller & Modigliani proposition) addressed the of slower long-term growth on asset values and returns. If growth slows, the payout ratio increases but stock valuations decline.

Ms. Richards argues that stock valuations may increase – and her argument drifts from noting lower earnings growth to a suggestion that the market might be expecting higher short-term earnings growth. It is not inconceivable that the market may expect higher future earnings, but in that case – wouldn’t the Samwick effect suggest a lower payout ratio?