Earnings or Dividends: Which had More Predictive Power?

Abstract

This paper reviews two important investment strategies employed by value investors; the Price to Earnings Ratio (“PER”) and Dividends yield (“DY”) strategy. In this paper, I review the performance of 16 portfolios formed on listed equity instruments on the Nigerian stock exchange (“NSE”) which were divided into quartiles within the period 2003 and 2014. I utilise various measures; “Jensen Alpha” measure and Sharpe ratio, to assess which portfolio would have earned Nigerian investors above market returns in the period.

The evidence from this study indicates that a portfolio formed using a market capitalization weighted approach for the highest quartile of dividend yielding stocks overall outperforms a buy-the-market and-hold policy. Also, equal weighted and market capitalization weighted portfolios based on earnings yield have been unable to outperform the NSE All Share Index in the review period. Put differently, the PER has no predictive power but dividends yields do. The limitations of the study are also discussed.

Keywords: Price to Earnings Ratio, Dividends yield, Nigeria, Jensen’s alpha, Sharpe ratio, Risk adjusted returns, Value investing