Dividends have always been an important criterion for choosing stocks as Graham and Dodd stated in 1940:
Experience would confirm the established verdict of the stock market that a dollar of earnings is worth more to the stockholder if paid him in dividends than when carried to surplus. The common-stock investor should ordinarily require both an adequate earning power and an adequate dividend.10
Graham and Dodd's claim has been supported by more recent research. In 1978, Krishna Ramaswamy and Robert Litzenberger established a significant correlation between dividend yield and subsequent returns.11 And more recently, James O'Shaughnessy has shown that in the period 1951 through 1994, the 50 highest-dividend-yielding large-capitalization stocks had a 1.7 percentage point higher return than the market.12
The historical analysis of the S&P 500 Index supports the case for using dividend yields to obtain higher stock returns. Using December 31 of each year from 1957 onward, I sorted the firms in the S&P 500 Index into five groups (or quintiles) ranked from the highest to the lowest dividend yields, and then I calculated the total returns over the next calendar year.
The striking results are shown in Figure 9-2. In strictly increasing order, the portfolios with higher dividend yields offered investors higher total returns than portfolios of stocks with lower dividend yields. If an investor put $1,000 in an S&P 500 Index fund at the end of Decem-
10 Graham and Dodd, Security Analysis, 2d ed., p. 381.
11 See Robert Litzenberger and Krishna Ramaswamy, "The Effects of Personal Taxes and Dividends on Capital Asset Prices: Theory and Empirical Evidence," Journal of Financial Economics, 1979, pp. 163-195.
12 James P. O'Shaughnessy, What Works on Wall Street, 3rd ed., New York: McGraw-Hill, 2003.
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