Is dividend yield an effective value metric? Not in the US, says Patrick O’Shaughnessy.

In a recent piece for his blog, “The Investor’s Field Guide”, O’Shaughnessy writes, “The [current] paltry yield available from the S&P 500 raises an interesting question. Is yield a good measure of cheapness? Short answer, for U.S. companies, is not anymore.”

O’Shaughnessy looked at the correlation between current dividend yield and current valuation percentile (market relative) going back to when interest rates peaked in 1981. “Since 2001, it has been in a clear downtrend,” he says. “Since the market peak in 2007, there has not been a meaningful relationship between yield and other measures of cheapness.”

Interestingly, O’Shaughnessy did find that high-dividend-yield stocks at one time enjoyed a valuation advantage, but that that advantage has disappeared in recent years. “One trend is somewhat stable: companies without a yield tend to be more expensive than other stocks,” he says. “But the more interesting trend is in the high yielders. Their valuation advantage has collapsed. Prior to the financial crisis bottom (pre-2009), the higher yielders were cheaper than the next bucket (2-4% yield) 92% of the time. Since 2009, they’ve only been cheaper 30% of the time. This is impossible to confirm, but the easiest explanation is that investors (especially older ones) have needed more income in this low rate environment, and have bid up the valuations of high yielders.”

O’Shaughnessy says that all this has a number of implications for investors. Among them: “If you are a value investor considering yield payers, use independent measures of valuation in your screening process,” he says. He also says to consider looking for dividend plays outside the US, where the relationship between valuation and dividends has been “quite different”, (something he says he’ll address in a future post). “More generally,” he adds, “you should never rely on a single factor when making decisions about a company.”