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Given the current elevated market volatility, we think now is a good time to revisit important value metrics with Southern California Edison employees and retirees in our four-part series. In the third part of this four-part value series, we will look at the Dividend Yield ratio.
We believe the Dividend Yield ratio can be a valuable tool in planning for Southern California Edison employees' retirements. Investors are often looking for ways for their clients to beat the market. If you're one of those investors, you may want to consider the following strategy that has been implemented by the investment greats. Some value investors have historically beat the average annualized returns of the S&P 500, and many have successful track records spanning several decades to prove it. The most famous value investor, of course, is Warren Buffett, but there are many others, including Benjamin Graham, David Dodd, Charlie Munger, Christopher Browne, and Seth Klarman.
This investment style focuses on four metrics that characterize a value investment. These four metrics include the Price-to-Earnings Ratio, the Price-to-Cash Flow Ratio, High Dividend Yield, and the Price-to-Book Ratio. These metrics, as you will see, are strong indicators of undervalued security. If undervalued security is brought back to fair value then we would see positive returns on that security. We will examine the effect of investing based on certain characteristics and how their investment returns are correlated.
The dividend yield is a popular value metric for investors for two reasons. First, it’s the obvious metric for investors favoring income over capital gains. Second, unlike earnings or cash flow, dividends are actually paid out to shareholders, and therefore independently verifiable. Where other metrics like price-to-book value, earnings or cash flow rely on management providing a true accounting of a company’s performance, the dividend is tangible proof of excess free cash flow. Thus, the argument goes, the dividend yield provides the most reliable picture of a company’s business performance, and prospects, which in turn may lead to better investment decisions and investment performance.
We understand the importance of research-driven solutions for Southern California Edison employees and retirees. Set out to the right, are the results of two Fama and French backtests of the dividend yield data from 1926 to 2013. As of December 2013, there were 3,393 firms in the sample. The value decile contained the 198 stocks with the highest earnings yield, and the glamour decile contained the 137 stocks with the lowest earnings yield (the deciles are smaller than 1/10th of the stocks in the sample because 1,894 stocks pay no dividend at all) (Carlisle-Div, P2).
The average size of glamour stocks is $8.60 billion and the average size of value stocks is $3.06 billion. Portfolios are formed on June 30 and rebalanced annually. In this backtest, the two portfolios are weighted by market capitalization, which means that bigger firms contribute more to the performance of the portfolio, and smaller firms contribute less. Here we can see that the value decile has outperformed the glamour decile, returning 10.3 percent compounded (13.4 percent in the average year) over the full period versus 8.3 percent for the glamour decile (11.3 percent in the average year) (Carlisle-Div, P3)
These returns are considerably lower than the returns found for the price-to-earnings and cash-flow ratios discussed previously. The reason is that the earnings and cash flow back tests ran back to only 1951, and the dividend yield data, like the book value return data, begins in 1926. The difference is partly due to the 1929 crash, which had an oversized impact on returns. The crash is visible on the chart and striking; it took almost twenty years for the value decile to fully recover.
To make a comparison possible of dividend yield’s performance to the performance of book, earnings, and cash flow over the same period, it's important that we also show Southern California Edison employees and retirees the measured returns beginning in 1951. Since 1951 the high dividend yield value decile has generated a compound annual growth rate (CAGR) of 11.4 percent and an average annual return (AAR) of 13.6 percent (Carlisle-Div, P5). Over the same period, the glamour decile returned a CAGR of 9.6 percent and an AAR of 12.9 percent. These returns are still considerably lower than the returns generated by the low PB, PCF, and PE studies over the same period.
The value premium is the outperformance of the value decile over the glamour decile. This chart provided for Southern California Edison employees and retirees shows the yearly returns of each of the value and glamour deciles, the value premium (value-glamour) in each year, and the rolling average from the start of the data in 1926.
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The rolling average tells a sad story for value relative to glamour: The value premium has gradually disappeared over time. Over the 73 years of data to 2000 it was actually zero, but it has slightly recovered since then to be 1.8 percent compounded over the full period (Carlisle-Div, P7). (The rolling average is the annualized average return for over the 5 yrs. following each year-long period (sometimes called a 5-year rolling return)
The following chart provided for Southern California Edison employees and retirees shows the returns to each of the deciles sorted by dividend yield (1 is glamour, and 10 is value). This chart shows that the dividend yield is a fair, but not great, metric for sorting stocks into value and glamour portfolios. This is due to the fact that less than half of all stocks pay dividends (only 44 percent pay dividends). A better comparison might be the dividend payers to the 1,894 stocks in the non-dividend paying cohort. The non-dividend payers underperformed all the dividend payers, generating a compound annual growth rate (CAGR) of 9.0 percent and an average annual return (AAR) of 13.5 percent over the full period (and, since 1951, a CAGR of 8.4 percent and an AAR of 13.2 percent) (Carlisle-Div, P8).
As we’ve discussed previously, value’s out. performance over glamour is not a historical anomaly. If we examine just the period since 1999, we find that value has been the better bet. Though value started out almost 40 percent behind in 1999, it outperformed glamour over the period since 1999, beating it by 5.2 percent compounded, and 6.5 percent in the average year–about the same differential for the low PB study (Carlisle-Div, P10). Market capitalization-weighted returns are useful for demonstrating that the outperformance of value over glamour is not due to the value portfolio containing small-cap stocks. Unless you’re running an index (or hugging an index), they’re not really meaningful.
The easiest portfolio weighting scheme is to simply equally weight each position. (If we’re prepared to put up with a little extra volatility for a little extra return, we can also Kelly weight our best ideas). Kelly Weighting is determined by the Kelly Criterion which is a formula used to determine what percentage of their capital should be used in each trade to maximize long-term growth. There are two key components to the formula (Kelly % = W- [(1 - W) / R]): the winning probability factor (W) and the win/loss ratio (R). The winning probability is the probability trade will have a positive return.
The win/loss ratio is equal to the total positive trade amounts divided by the total negative trading amounts. The result of the formula will tell investors what percentage of their total capital that they should apply to each investment. Here are the equal weight return statistics for dividend yield.
In the equal weight backtest, value generated 12.7 percent compounded return (16.1 percent on average), beating out glamour’s 11.6 percent compounded return (15.5 percent on average) (Carlisle-Div, P11).
Since 1951, the equally weighted high dividend yield value decile has generated a compound annual growth rate (CAGR) of 13.5 percent and an average annual return (AAR) of 15.7 percent. Over the same period the glamour decile returned a CAGR of 12.5 percent and an AAR of 15.5 percent. These returns are still slightly lower than the returns generated by PB, PCF and PE over the same period (Carlisle-Div, P12).
Again, the value premium was never very large for the equal weight portfolios and has gradually diminished to 1.1 percent compounded over the full period. We see again that the dividend yield doesn’t do a great job sorting glamour and value portfolios. The dividend payers do, however, comprehensively outperform the non-dividend paying cohort, which returned a CAGR of 13.4 percent and an AAR of 21.2 percent over the full period (and, since 1951, a CAGR of 12.4 percent and an AAR or 18.3 percent) (Carlisle-Div, P14). For this reason, we believe- dividend yields can be a valuable tool for Southern California Edison employees.
Michael Keppler, who wrote “The Importance of Dividend Yields in Country Selection”, focused on the effect of stock returns based on dividend yield. He examined Australia, Austria, Belgium, Canada, Denmark, France, Germany, Hong Kong, Italy, Japan, The Netherlands, Norway, Singapore/Malaysia, Spain, Sweden, Switzerland, the United Kingdom and the United States. The study assumes each quarter an equal weighted portfolio is composed by dividing each of the 18 Morgan Stanley international equity indexes into quartiles based on their dividend yield. As seen in the following graph, the highest dividend yielding quartile significantly outperforms its low dividend paying counterparts.
The highest paying dividend quartile returned 18.49% compounded and 19.08% compounded when adjust to US dollars. The lowest paying quartile only returned 5.74% and 10.31% compounded when converted to US dollars. The MSCI World Index returned 12.14% compounded annually and 13.26% when converted to US dollars (Tweedy Browne, p.32). We can see from this evidence that high paying dividend companies significantly outperform non-dividend paying companies.
While there is a slight correlation that high dividend companies outperform low dividend companies, we must agree that ultimately it is the fact that dividend paying companies historically outperform non-dividend paying companies.
In a more recent study by Manning & Napier Advisors, LLC, they find that high dividend yield stocks still outperform the low to no dividend-paying stocks. They look at the performance, for a 25-year period (1990-2015), of high cash flow yield and high dividend yield stocks independently as well as how they can be used together.
As can be seen in Figure 2, screening for high dividend yield stocks can protect the downside. This is due to the fact that the companies that pay higher dividends are returning capital to their investors which eliminates the uncertainty that comes with companies carrying cash. In fact, Figure 3 shows that a significant (over 40%) part of total return from 1926 to 2015 has come from dividends as opposed to capital appreciation.
In addition, we'd like to point out to Southern California Edison employees that higher dividend yields have generated better capital stability for investors. Figure 5 shows that higher dividend yields have demonstrated lower downside capture since 1990. This limited downside can be important for Southern California Edison retirees looking for both current income and low volatility.
As can be seen in these three studies we've provided for Southern California Edison employees, it is apparent that by simply screening for high-dividend stocks with no fundamental analysis it is possible to outperform non-dividend paying stocks. Unlike the P/E, P/CF ratios, and ultimately the P/B ratio, which are all very useful metrics for sorting cheap stocks from expensive stocks, the dividend yield is less useful. This is likely because only around 44 percent of all stocks pay dividends. The message seems to be clear, that expensive stocks and undervalued stocks that pay dividends outperform all non-dividend paying stocks. Reinforcing this metric are the value-oriented track records of notable names such as Warren Buffet, Bruce Berkowitz, and Seth Klarmen who all use the dividend yield as a supplemental indicator for their investment universe.
The Retirement Group is a nation-wide group of financial advisors who work together as a team.
We focus entirely on retirement planning and the design of retirement portfolios for transitioning corporate employees. Each representative of the group has been hand selected by The Retirement Group in select cities of the United States. Each advisor was selected based on their pension expertise, experience in financial planning, and portfolio construction knowledge.
TRG takes a teamwork approach in providing the best possible solutions for our clients’ concerns. The Team has a conservative investment philosophy and diversifies client portfolios with laddered bonds, CDs, mutual funds, ETFs, Annuities, Stocks and other investments to help achieve their goals. The team addresses Retirement, Pension, Tax, Asset Allocation, Estate, and Elder Care issues. This document utilizes various research tools and techniques. A variety of assumptions and judgmental elements are inevitably inherent in any attempt to estimate future results and, consequently, such results should be viewed as tentative estimations. Changes in the law, investment climate, interest rates, and personal circumstances will have profound effects on both the accuracy of our estimations and the suitability of our recommendations. The need for ongoing sensitivity to change and for constant re-examination and alteration of the plan is thus apparent.
Therefore, we encourage you to have your plan updated a few months before your potential retirement date as well as an annual review. It should be emphasized that neither The Retirement Group, LLC nor any of its employees can engage in the practice of law or accounting and that nothing in this document should be taken as an effort to do so. We look forward to working with tax and/or legal professionals you may select to discuss the relevant ramifications of our recommendations.
Throughout your retirement years we will continue to update you on issues affecting your retirement through our complimentary and proprietary newsletters, workshops and regular updates. You may always reach us at (800) 900-5867.
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Carlisle, Tobias. “Investing Using the Price-to-Earnings Ratio and Earnings Yield (Backtests 1951 to 2013)”. May 26, 2014. <http://greenbackd.com/2014/05/26/price-to-earnings-ratio-backtest-1951-to-2013/>.
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Hobson, Ben. “Don't get your head turned by glamour shares: How David Dreman perfected the art of contrarian stock-picking”. April 2013 <http://www.thisismoney.co.uk/money/diyinvesting/article-2308111/David-Dreman-art-contrarian-stock-picking.html>.
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Tweedy Browne Company LLC. “What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated with Exceptional Returns.” 1992.<http://www.tweedy.com/resources/library_docs/papers/WhatHasWorkedFundVersionWeb.pdf>.
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Manning & Napier Advisors. “Free Cash Flow and Dividends: How A Focus On Yield Can Help Investors Provide for Today and Prepare for Tomorrow” April 2016.
How does SoCalGas determine its pension contribution levels for 2024, and what factors influence the funding strategies to maintain financial stability? In preparing for the Test Year (TY) 2024, SoCalGas employs a detailed actuarial process to ascertain the necessary pension contributions. The actuarial valuation includes an assessment of the company's Projected Benefit Obligation (PBO) under Generally Accepted Accounting Principles (GAAP). These calculations incorporate variables such as current employee demographics, expected retirement ages, and market conditions. Additionally, SoCalGas must navigate external economic factors, including interest rates and economic forecasts, which can impact the funded status of its pension plans and the associated financial obligations.
SoCalGas determines its pension contribution levels using a detailed actuarial process that evaluates the Projected Benefit Obligation (PBO) under Generally Accepted Accounting Principles (GAAP). The contribution is influenced by variables such as employee demographics, retirement age expectations, market conditions, and external economic factors like interest rates and economic forecasts. SoCalGas maintains financial stability by adjusting funding strategies based on market returns and required amortization periods(Southern_California_Gas…).
What specific changes to SoCalGas's pension plan are being proposed for the upcoming fiscal year, and how will these changes impact existing employees and retirees? The proposals for the TY 2024 incorporate adjustments to the existing pension funding mechanisms, including the continuation of the two-way balancing account to account for fluctuations in pension costs. This measure is designed to stabilize funding while meeting both the service cost and the annual minimum contributions required under regulatory standards. Existing employees and retirees may see changes in their benefits as adjustments are made to align with these funding strategies, which may include modifications to expected payouts or contributions required from retirees depending on their service years and retirement age.
For the 2024 Test Year, SoCalGas is proposing to adjust its pension funding policy by shortening the amortization period for the PBO shortfall from fourteen to seven years. This change aims to fully fund the pension plan more quickly, improving long-term financial health while reducing intergenerational ratepayer burden. Existing employees and retirees may experience greater financial stability in the pension plan due to these proactive funding strategies(Southern_California_Gas…).
In what ways does SoCalGas's health care cost escalation projections for postretirement benefits compare with national trends, and what strategies are in place to manage these costs? The health care cost escalations required for the Postretirement Health and Welfare Benefits Other than Pension (PBOP) at SoCalGas have been developed in alignment with industry trends, which show consistent increases in health care expenses across the nation. Strategies implemented by SoCalGas involve negotiation with health care providers for favorable rates, introduction of health reimbursement accounts (HRAs), and ongoing assessments of utilization rates among retirees to identify potential savings. These measures aim to contain costs while ensuring that retirees maintain access to necessary healthcare services without a significant financial burden.
SoCalGas's healthcare cost projections for its Postretirement Benefits Other than Pensions (PBOP) align with national trends of increasing healthcare expenses. To manage these costs, SoCalGas employs strategies like negotiating favorable rates with providers, utilizing health reimbursement accounts (HRAs), and regularly assessing healthcare utilization. These efforts aim to control healthcare costs while ensuring that retirees receive necessary care(Southern_California_Gas…).
What resources are available to SoCalGas employees to help them understand their benefits and the changes that may occur in 2024? SoCalGas provides various resources to employees to clarify their benefits and upcoming changes, including dedicated HR representatives, comprehensive guides on benefits options, web-based portals, and informational seminars. Employees can access personalized accounts to view their specific benefits, contributions, and projections. Additionally, the company offers regular training sessions covering changes in benefits and how to navigate the retirement process effectively, empowering employees to make informed decisions regarding their retirement planning.
SoCalGas provides employees with various resources, including HR representatives, benefit guides, and web-based portals to help them understand their benefits. Employees also have access to personalized retirement accounts and training sessions that cover benefit changes and retirement planning, helping them make informed decisions regarding their future(Southern_California_Gas…).
How does the PBOP plan impact SoCalGas’s overall compensation strategy for attracting talent? The PBOP plan is a critical component of SoCalGas’s total compensation strategy, designed to attract and retain high-caliber talent in an increasingly competitive market. SoCalGas recognizes that comprehensive postretirement benefits enhance their appeal as an employer. The direct correlation between competitive benefits packages, including the PBOP plan's provisions for health care coverage and financial support during retirement, plays a significant role in talent acquisition and retention by providing peace of mind for employees about their long-term financial security.
SoCalGas's PBOP plan plays a crucial role in its overall compensation strategy by offering competitive postretirement health benefits that enhance the attractiveness of the company's total compensation package. This helps SoCalGas attract and retain a high-performing workforce, as comprehensive retirement and healthcare benefits are important factors for employees when choosing an employer(Southern_California_Gas…).
What are the anticipated trends in the pension and postretirement cost estimates for SoCalGas from 2024 through 2031, and what implications do these trends hold for financial planning? Anticipated trends in pension and postretirement cost estimates are projected to indicate gradual increases in these costs due to changing demographics, increasing life expectancies, and inflation impacting healthcare costs. Financial planning at SoCalGas thus necessitates a proactive approach to ensure adequate funding mechanisms are in place. This involves forecasting contributions that will remain in line with the projected obligations while also navigating regulatory requirements to avoid potential funding shortfalls or impacts on corporate finances.
SoCalGas anticipates gradual increases in pension and postretirement costs from 2024 to 2031 due to changing demographics, increased life expectancies, and rising healthcare costs. This trend implies that SoCalGas will need to implement robust financial planning strategies, including forecasting contributions and aligning funding mechanisms with regulatory requirements to avoid potential shortfalls(Southern_California_Gas…).
How do SoCalGas's pension plans compare with those offered by other utility companies in California in terms of competitiveness and sustainability? When evaluating SoCalGas's pension plans compared to other California utility companies, it becomes evident that SoCalGas's offerings emphasize not only competitive benefits but also a sustainable framework for its pension obligations. This comparative analysis includes studying funding ratios, benefit structures, and employee satisfaction levels. SoCalGas aims to maintain a robust pension plan that not only meets current employee needs but is also sustainable in the long term, adapting to changing economic conditions and workforce requirements while remaining compliant with state regulations.
SoCalGas's pension plans are competitive with those of other utility companies in California, with a focus on both benefit structure and long-term sustainability. SoCalGas emphasizes maintaining a robust pension plan that is adaptable to changing market conditions, regulatory requirements, and workforce needs. This allows the company to remain an attractive employer while ensuring the sustainability of its pension commitments(Southern_California_Gas…).
How can SoCalGas employees reach out for support regarding their pension and retirement benefits, and what types of inquiries can they make? Employees can contact SoCalGas’s Human Resources Benefits Department through dedicated communication channels such as the company’s HR support line, email, or scheduled one-on-one consultations. The HR team is trained to address a variety of inquiries related to pension benefits, eligibility requirements, plan options, and retirement planning strategies. Moreover, employees can request personalized benefits statements and assistance with understanding their entitlements and the implications of any regulatory changes affecting their plans.
SoCalGas employees can reach out to the company's HR Benefits Department through a dedicated support line, email, or consultations. They can inquire about pension benefits, eligibility, plan options, and retirement strategies. Employees may also request personalized benefits statements and clarification on regulatory changes that may affect their plans(Southern_California_Gas…).
What role does market volatility and economic conditions play in shaping the funding strategy of SoCalGas's pension plans? Market volatility and economic conditions play a significant role in shaping SoCalGas's pension funding strategy, influencing both asset returns and liabilities. Fluctuations in interest rates, market performance of invested pension assets, and changes in demographic factors directly affect the PBO calculation, requiring SoCalGas to adjust its funding strategy responsively. This involved the use of sophisticated financial modeling and scenario analysis to ensure that the pension plans remain adequately funded and financially viable despite adverse economic conditions, thereby protecting the interests of current and future beneficiaries.
Market volatility and economic conditions significantly impact SoCalGas's pension funding strategy, affecting both asset returns and liabilities. Factors like interest rates, market performance of pension assets, and demographic shifts influence the PBO calculation, prompting SoCalGas to adjust its funding strategy to ensure adequate pension funding and long-term plan viability(Southern_California_Gas…).
What steps have SoCalGas and SDG&E proposed to recover costs related to pension and PBOP to alleviate financial pressure on ratepayers? SoCalGas and SDG&E proposed implementing a two-way balancing account mechanism designed to smoothly recover the costs associated with their pension and PBOP plans. This initiative aims to ensure that any variances between projected and actual contributions are adjusted in a timely manner, thereby reducing the financial burden on ratepayers. By utilizing this approach, the Companies seek to maintain stable rates while ensuring that all pension obligations can be met without compromising operational integrity or service delivery to their customers. These questions reflect complex issues relevant to SoCalGas employees preparing for retirement and navigating the nuances of their benefits.
SoCalGas and SDG&E have proposed utilizing a two-way balancing account mechanism to recover pension and PBOP-related costs. This mechanism helps adjust for variances between projected and actual contributions, ensuring that costs are managed effectively and do not overly burden ratepayers. This approach aims to maintain stable rates while fulfilling pension obligations(Southern_California_Gas…).