Payout yield as an alternative to dividend yield

An important piece of research caught my eye on the back cover of the Journal of Finance, “On the Importance of Measuring Payout Yield: Implications for Empirical Asset Pricing”. (See the paper for details.) This article by Jacob Boudoukh, Roni Michaely, Matthew Richardson and Michael Roberts (BMRR) is a deep and careful piece of research which addresses an important issue in equity pricing models. 

Significant research on dividend yield has shown that it is an important factor in the pricing of stocks both cross sectionally and through time. Generally, it is viewed that high dividend yield suggests that the market is undervalued while low dividend yield suggest high equity valuation. The dividend yield is fundamental to the Gordon growth model and for the Fama-French three factor model. Nevertheless, there has been a significant fall-off in the significance of dividend yield as pricing factor in the last 15 years. Researchers have been puzzled by this change. Some have suggested that the market has adapted or adjusted to using the dividend yield which is the cause for the declining significance while others state that the initial importance of dividend yield was illusionary. 

BMRR take a different approach through analyzing payout yield instead of the dividend yield. The approach is straightforward. What is relevant is not just the dividend yield but also repurchases which have become to serve as a substitute for dividend yield. Additionally, the net payout which is the combination of dividends and repurchase minus issuance would be a better measure of net cash flows in the equity market. The intuition behind using payout ratios seems to fit the facts for the United States over the last fifteen years at the same time that dividend yield began to diminish in importance. Share repurchases have become a bigger share of payout and the huge issuance of new stock during the technology boom forces the net payout to decline in a manner consistent with market over valuation. 

More important than the stylized facts about payout is the careful empirical work which shows that payout ratios have better explanation power than dividend yield. Payout ratios provide economically significant predictability relative to the dividend yield. The differential between high and low payout yields is a priced factor.