High dividends point to earnings growth

Paying dividentsHigh dividend payout ratios are a sign that corporate earnings are set to increase, says a report by Allianz Global Investors that predicts earnings growth in the coming years.

The report challenges those who see high dividends as a sign that earnings will decline. According to this view, companies grow fastest when they reinvest their retained earnings rather than distribute them to shareholders.

The Allianz Global Investors' report refers to a 2003 study by Robert D. Arnott and Clifford S. Asness called 'Surprise! Higher Dividends = Higher Earnings Growth'. In it, the authors argue that high dividends indicate confidence in a company of high future earnings. Companies which pay high dividends are more likely to approach lenders for funding, which gives rise to a high level of discipline that helps their projects become viable.

Although substantial reinvestment of funds is usually seen as positive, it can also be a sign of “inefficient empire building”, argued Arnott and Asness.

Allianz Global Investors' chief economist, Stefan Hofrichter, said recent history supports the report findings.

“The 1990s, in which dividend payout ratios reached a low, were marked by over-investment in information technology (IT) and telecommunications. This resulted in the recession and profit collapse in the early 2000s,” he said.

©2012 funds europe