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Value Series III: Value Investing and Dividends for Dow Incorporated Employees and Retirees

Given the current elevated market volatility, we think now is a good time to revisit important value metrics with Dow Incorporated 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 Dow Incorporated 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 Dow Incorporated 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 Dow Incorporated 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 Dow Incorporated 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.

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 Dow Incorporated 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 Dow Incorporated 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.

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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 Dow Incorporated 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 Dow Incorporated retirees looking for both current income and low volatility.

As can be seen in these three studies we've provided for Dow Incorporated 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/>.
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>.
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>.
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 The Dow Chemical Companyâ€™s pension plan structure impact an employee's retirement benefits when considering different retirement ages? The Dow Chemical Company offers various options in its pension plan, and understanding these can significantly affect financial planning for retirement. An employee must weigh the benefits of retiring earlier with potentially lower monthly payments against the advantages of working longer and how this aligns with personal retirement goals and expectations.

The Dow Chemical Company’s pension plan and retirement ages: The Dow Chemical Company’s pension plan structure impacts employees' retirement benefits based on their retirement age. Retiring earlier results in lower monthly payments due to reduced service time and potential early commencement penalties, while working longer allows for more service accrual and higher monthly benefits. Employees must evaluate how these factors align with personal retirement goals, as choosing to retire early might not provide as much financial security as delaying retirement(The Dow Chemical Compan…).

What are the implications of the 20% mandatory withholding tax on lump-sum distributions from The Dow Chemical Company's pension plan, and how does the option to roll over affect an employeeâ€™s tax situation? Employees taking lump-sum distributions need to be cautious about this withholding rule as it can impact their immediate financial needs. Additionally, the rollover option provides a strategy to defer taxes, which can be crucial for long-term financial health. Employees should consider how to best utilize these rules in their personal financial planning.

20% mandatory withholding tax on lump-sum distributions: Lump-sum distributions from The Dow Chemical Company’s pension plan are subject to a 20% mandatory withholding tax if not directly rolled over into another qualified retirement plan. This tax can significantly impact an employee's immediate finances. However, opting to roll over the lump sum to a qualified plan defers taxation until funds are withdrawn, allowing employees to manage their tax liabilities better while continuing to grow their retirement savings(The Dow Chemical Compan…).

How does The Dow Chemical Company ensure that employees understand their eligibility for retirement benefits based on various service and age criteria? Eligibility considerations based on service years and age can significantly influence the retirement timeline for employees. Moreover, itâ€™s essential for employees to be well-informed about these factors to make educated decisions pertaining to their retirement and whether adjustments to their career plans are needed for maximizing benefits.

Eligibility for retirement benefits: The Dow Chemical Company outlines eligibility for pension benefits based on a combination of service years and age. Typically, employees become vested after three years of service or upon reaching age 65 while still employed. The company ensures that employees are informed about these eligibility criteria through various resources, such as the Dow Benefits Service Center, enabling them to make informed retirement decisions(The Dow Chemical Compan…).

In what ways can employees of The Dow Chemical Company appeal decisions regarding their pension benefits, and what processes are in place to facilitate these appeals? The appeal process is critical for employees who might feel that their benefits have not been administered correctly. Understanding the correct procedures and having access to the right resources can empower employees to effectively advocate for themselves in the face of administrative decisions.

Appealing pension benefit decisions: If employees believe there has been an error in the administration of their pension benefits, The Dow Chemical Company provides a formal appeal process. Employees can file a claim, and if denied, they have the right to appeal the decision. The Retirement Board oversees these appeals, and employees must follow the outlined procedures for their appeal to be considered(The Dow Chemical Compan…).

What strategies can employees of The Dow Chemical Company employ to maximize their pension benefits while transitioning to retirement? Employees must navigate complexities such as contribution limits, benefit formulas, and personal retirement savings. A strategic approach, which includes understanding the timing of retirement and how it interacts with pension claims, can lead to more favorable financial outcomes in their retirement years.

Maximizing pension benefits: Employees at The Dow Chemical Company can maximize their pension benefits by carefully planning their retirement timing. Key strategies include working longer to accrue more service years, reviewing contribution limits, and understanding the benefit formula used. Aligning personal savings and pension claims with the optimal retirement age can result in more favorable financial outcomes(The Dow Chemical Compan…).

How can retirees from The Dow Chemical Company navigate survivor benefits, and what are the eligibility criteria for spouses or domestic partners? Survivor benefits are an essential aspect of retirement planning, especially for employees concerned about providing for their loved ones after death. Itâ€™s vital for employees to understand both eligibility and what benefits their partners might receive, fostering peace of mind during retirement planning endeavors.

Survivor benefits for retirees: Retirees from The Dow Chemical Company can opt for survivor benefits to provide financial security for their spouses or domestic partners. Eligibility for these benefits depends on the plan's structure, and employees should understand the options available to ensure their loved ones are covered after their death. These benefits include continued monthly payments or lump-sum options depending on the election made at retirement(The Dow Chemical Compan…).

How does The Dow Chemical Companyâ€™s defined benefit pension plan differ from other retirement plans, and what should employees know when comparing their options? Employees need to understand the distinctions between defined benefit plans and other types such as defined contribution plans for effective retirement planning. This understanding will help them better appreciate the benefits and risks associated with their choices and aid with decision-making processes.

Comparing defined benefit pension plan: The Dow Chemical Company offers a defined benefit pension plan, which differs from defined contribution plans like 401(k)s. In a defined benefit plan, the company guarantees a specific monthly benefit upon retirement, typically based on years of service and salary, whereas defined contribution plans depend on employee contributions and investment performance(The Dow Chemical Compan…).

What resources does The Dow Chemical Company provide to employees seeking detailed information about their retirement options, and how can they effectively utilize these? Accessing the right resources can bridge knowledge gaps regarding pension plans. Employees should know about dedicated pathways to assistance, such as benefit service centers and consultation avenues, to fully leverage their benefits package.

Resources for retirement information: The Dow Chemical Company provides several resources for employees to access detailed information about their retirement options. The Dow Benefits Service Center and My HR Connection are key tools where employees can request pension estimates, understand payment options, and clarify eligibility criteria. These resources help employees make informed decisions regarding their retirement planning(The Dow Chemical Compan…).

With changes in IRS rules becoming increasingly relevant, how do employees of The Dow Chemical Company stay informed about updates that may impact their retirement savings? Employees need to be active participants in their retirement planning by staying abreast of legal and regulatory changes that can influence their financial strategies. Having a clear understanding of these regulations can help ensure compliance while maximizing possible financial benefits under updated laws.

Staying informed about IRS rules: Employees of The Dow Chemical Company must stay informed about IRS rules that may affect their retirement savings. Changes in tax laws, contribution limits, or distribution rules can significantly impact financial planning. The company provides updates and resources to ensure employees are aware of relevant regulatory changes that might affect their retirement strategies(The Dow Chemical Compan…).

How can employees of The Dow Chemical Company reach the benefits service center for additional inquiries regarding their pension plan, and what information should they prepare beforehand? Knowing how to contact the benefits service center is crucial for employees seeking clarity on their pension plan benefits. Preparing relevant information ahead of time can streamline the process, allowing for a more productive engagement with benefits specialists and ensuring that employees receive precise guidance tailored to their situations.

Contacting the benefits service center: Employees seeking clarification about their pension benefits can reach the Dow Benefits Service Center via phone or online through the Message Center. It is recommended to have personal identification and details of the pension plan ready to streamline the inquiry process. Proper preparation ensures a productive conversation with benefits specialists(The Dow Chemical Compan…).

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For more information you can reach the plan administrator for Dow Incorporated at 1919 torrance blvd Torrance, CA 90501; or by calling them at 900-999-1009.