no bubble

JW Mason jwm at
Tue Apr 11 22:07:59 PDT 2000

Doug Henwood wrote:

> Why use market cap here? Why not profits or cash flow, which is a
> better measure of the sustainability of the high-payout strategy?

The original motivation of this exercise was a calculation Dean Baker did. Taking the long-term stock market returns as equal to profit growth plus dividend yield, and assuming the historical premium of equity returns over short-term government bonds, the question was how far stock values would have to fall to restore that premium. (The answer was 50%, give or take.) I wondered what would happen if you counted net stock purchases as dividends, as it seems clear you should. (I also wondered -- and still wonder -- what good basis there is for expecting the historical equity premium to continue to apply in the future.) So the main reason I started with market cap is that Dean did.

> From 1952-81, corps paid out 21% of cash flow in the form of
> dividends less new equity issues; from 1982-99, that average was 38%;
> since 1995, it's been 48%. Investors may be valuing their payouts in
> line with previous averages, but are they being rationally exuberant
> to regard these payouts as sustainable?

Well, that's the question. Personally, I'd say:

1. Even if current payouts aren't sustainable, there's a difference between the irrationality of believing that current payout ratios will continue, and believing that current profit growth rates will increase sharply. Aren't investors *supposed* to respond to dividends? -- i.e. to trust management's judgement on the level of payout that can be sustained? More importantly, a bubble in the sense of increases in asset values driven by expectations of further increases generally has to keep expanding or else collapse abruptly. Changes in the payout ratio presumably don't have that all-or-nothing quality.

2. As you note, even if the most recent levels of payout can't be sustained, payouts have been elevated well above their historic levels since the early '80s. If something that's gone on for two decades isn't sustainable, I don't know what is. When a larger portion of earnings are going directly to their pockets, investors are right to value those earnings more highly. So I feel skeptical toward any evaluation of the stock market that simply compares current P/E ratios to their long-term average.

3. Over the 1982-99 period, a big part of the increase in payouts has been financed by reduced investment -- 24% of profits, compared with 31% for the earlier period. To the extent that investment can be reduced without reducing future profit growth too much, investors are again right to value a dollar of earnings higher.

What do you think? Is the current payout ratio unsustainable? Net stock purchases do seem to have been dropping pretty rapidly over the last few quarters. But if borrowing to fund share buybacks is unsustainable, why are companies doing it? It's hard to blame Abby Joseph Cohen for this one.


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