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Markus
Rosgen, a Citigroup Inc. equity strategist in Hong Kong,
has turned the commonly used metric of dividend yield on
its head with interesting results.
The
inverse of dividend yield is, of course, the price of a
share divided by its most recent payout.
The
measure can be thought of as a dividend-payback period,
with a 5-percent yield implying a 20-year horizon for
return of capital to the investor, discounting any gain
or loss from a change in the stock price.
“The
concept is simple,” Rosgen says. “Assuming no increase
in the payout ratio, no rise in dividends, how long will
it take investors to get the current outlay back in the
form of dividends?”
Well,
the answer is almost 73 years for the MSCI India index,
which makes the third-biggest Asian economy “the most
expensive market in the region,” Rosgen and his
colleagues, Elaine Chu and Brian Li, said in a report
yesterday.
When the
outlook for capital appreciation is clouded—as it is
now, by high food and fuel prices, a global credit
crunch and dinner-table talk of stagflation—it’s quite
natural that investors will look for stocks that have
more assured payoffs.
That was
a key insight of a 1991 study, titled, “The Equity Yield
Curve,” by Richard Bernstein, Merrill Lynch & Co.’s
chief US strategist, and Bernard Tew, a fund manager who
now works for New York Life Investment Management.
“In an
uncertain economic environment, most investors would
rather own a short payback asset,” the Citigroup
researchers say, identifying Pakistan (16 years) and
Taiwan (22 years) as more attractive than not only
India,
but also South Korea (54 years) and China (39 years).
‘Generation too far’
The
inverse of the payout yield is a crude measure because
it supposes that a company’s cash flows won’t change in
the future, an assumption that holds for mature
enterprises in developed economies, but not for their
fast-growing rivals.
Even so,
a payback period that’s too long could be an important
clue that prices are unsustainable. “India,
with a 113-year payback in January 2008, was just a
generation too far for most investors,” say Rosgen and
his colleagues.
Sure
enough, the benchmark Bombay Stock Exchange Sensitive
Index, or Sensex, has declined 30 percent this year in
US dollar terms, the fourth-worst performer in Asia
after Vietnam, China and the Philippines.
So far
this year, foreign investors have sold a net $5.5
billion in Indian equities, spooked by a surge in
inflation.
‘Duration’ equivalent
Another
way to view the dividend-payback period is to think of
it as a rough-and-ready stock-market equivalent of what
fixed-income investors know as “duration,” or the
sensitivity of a bond price to interest rates. (One
important caveat: Bernstein’s research found little
correlation between dividend yields and sensitivity of
stocks to interest rates.)
While
duration is a standard tool in the bond researcher’s
kit, measuring the sensitivity of equity prices to rate
changes is “more recent,” David Blitzer, chairman of the
index committee at Standard & Poor’s (S&P) in New York,
said in a 2004 paper he cowrote with his colleague
Srikant Dash.
The
literature on equity duration goes back less than 25
years “and its use in investment management is far from
widespread,” Blitzer and Dash said.
The S&P
analysts calculated the equity duration for the US stock
market and found that it had reached a 15-year high a
little before the Federal Reserve began raising interest
rates in mid-1999. Everyone knows that US stocks
collapsed because the dot-com bubble burst. But the high
vulnerability of equity prices to the rising cost of
capital may also have played a role. S&P analysis showed
that was the case during that time.
Lessons
everywhere
Subsequent reductions in borrowing costs didn’t help,
the S&P analysts said, because the equity duration, or
sensitivity of stock prices to interest rates, also
slumped to a 10-year low.
The S&P
500 lost 49 percent of its value from March 2000 to
October 2002. That episode may provide a lesson for
investors in India, where the cost of capital is rising.
The
Indian central bank increased its benchmark interest
rate by a quarter percentage point last week to 8
percent, which compares with 6 percent three years ago.
With
inflation at its fastest in seven years, Indian interest
rates may have to climb still higher.
If
Indian equities are, at present, vulnerable to interest
rates because of their duration, then the chances of a
drop in the index are high. Credit Suisse Group’s
forecast is for the Sensex to fall to 13,000 by the end
of this year, a further 16-percent decline from the
current level.
Another
relevant example may be of Taiwan, which, like India,
had a dividend-payback period in excess of 100 years: in
1997 and in 2000.
It
seemed that investors would wait for two or three
generations to get their money back. That show of
patience proved to be ephemeral, and Taiwanese companies
had to increase their payout ratios, Rosgen and his
colleagues noted in a research note they wrote in
January.
Indian
companies may have to do the same as investors prod them
for a money-back guarantee—in this life. |
