An old adage holds that investors in dividend stocks are being "paid to wait for the stock to appreciate." Academic research suggests they may not have to wait very long. Dividends, it turns out, can actually forecast earnings growth. And earnings growth, of course, drives stock gains.
The idea that dividends can foreshadow earnings sounds illogical, like using a sore backside to predict a kick in the pants. Dividends, after all, are paid with the money a company earns. One would expect earnings growth to predict dividends, not the other way around. But it works.
Robert Arnott and Clifford Asnes studied the relationship between the percentage of earnings paid out as dividends - what's known as the payout ratio - and subsequent earnings growth. They studied 130 years of dividend data, but focused primarily on S&P 500 numbers since 1946, which they called the "modern period."
Their findings in their paper "Surprise! Higher Dividends = Higher Earnings Growth" defy conventional wisdom that dividend payers are slow growers. Higher payout ratios predicted faster earnings growth over the next 10 years.
-- Jack Hough, SmartMoney, October 2005
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