Is Dividend Yield a Good Indicator of Value?

Dividend yield = dividend per share received / price of one share

Other than equity risk premium to measure whether stock market as a whole is normal/under-valued/over-valued, I wonder and have considered that dividend yield is another good indicator as well.

The reason why I came to this conclusion is as follows,

You see, as far as an individual company is concerned, we will never know more private and inside information than the managers running the company even if you own one share of the company and technically considered an owner of the company.

However, the company dividend policy is a good signal of whether its future growth is bright or less than ideal. Take a good look at the findings done by Robert D Arnott and Clifford S Asness, their conclusion seems to be that higher dividend payouts ratio correlate to higher earnings growth and earnings growth will eventually leads to higher stock prices.

The fundamental reason may be explained as follows, if managers do not need to retain much cash, then it is more efficient in using company’s resources. If the company fundamental is good, then it don’t really need much of the retained earnings to grow, the revenue itself should be more than adequate to fund growth.

If we extrapolate this idea to the average dividend yield of all the listed stocks in a particular chosen stock market, then average dividends yield is a good indicator to decide when to buy/sell/hold stocks, in conjunction with other decisions making models to further reduce uncertainty.

As you can see, common sense will tell you that if a share’s dividend yield is constantly high for more than a year, it is most likely a good bargain and vice versa. As a result, the average dividend yield of all the company stocks listed on a stock exchange can suggests to you whether market is seriously overvalued or undervalued. This is another measure for doing market cycle investing using either index funds or blue chips.

You may want to check historical data for the following things; an overly high average dividend yield is followed by a high stock market returns one or two years later, or that together with returns from capital appreciation of all stocks as a whole is usually followed in 4 years time, at the most.

To further apply the concepts presented here, one may plot data of average dividend yield and stock market index value and use the statistical concept of regression analysis for even more detailed analysis.