While I am researching the topic of high dividend strategies, I have been shared this nugget of knowledge. Did anyone ever heard of this before?
Ability To Pay (ATP): A RATIO HELPING INVESTORS FIND SUSTAINABLE DIVIDENDS
When growth prospects slow, stocks that are able to maintain their dividends tend to outperform while those that cut their dividends tend to be punished and often underperform the market. As we are at the end of a business cycle and migh experience growth slowdown, the Ability To Pay Ratio is a must-have ratio for dividend investors.
The Ability to Pay (ATP) ratio looks at how much cash a company has to pay out after operating expenses per every dollar of common dividends it has declared.
Ability to Pay Ratio (ATP) = (Cash Flow - Preferred Dividends - CAPEX)/Common Dividends
Supposedly it is working wonderfully but I haven’t tested it yet inside a ranking system or a simulation.
Nothing new here. It’s just the reciprocal of a payout ratio based on FCF rather than net income, one of many variations of the payout ratios that have been in widespread use for a long time.
As with other payout ratios, its helpful but not a silver bullet. All of these payouts are have to be interpreted in light of the nature of the company’s business (the less volatile a business, the higher the payout is feasible — and expected. And as far as where we are in the cycle, this ratio, like all others, tells us what we saw in the past. We need to hunt for clues re: the future.
I’ve been seeing over the years, that Mr. Market is remarkably good at assessing future dividend security. Don’t underestimate how much help you can get by looking at the current yield relative to others (the higher the riskier) and plain-vanilla technical-sentiment-momentum analysis. That’s where you’re likely to gain an edge on the market, because that’s not widely examined. OTOH, every imaginable variation on the payout ratio has already been studied to death and is not likely to give you insights not also being seen by countless others.
My impression is that the market for dividend paying stocks in general has been favorable for a long time as interest rates have dropped, starting in the 1980s. As interest rates (slowly) rise, will that fundamental attraction go away? I have seen in the news recently that dividend paying stocks seem to be less preferred as the Fed raises rates. So there could be a systemic jeopardy in thinking that the tailwinds that pushed these stocks forward for the last 30 years will just continue.
That’s probably a pretty accurate description of what we’re looking at going forward. But here are some other wrinkles:
That tailwind has been powering all stocks including – especially I might argue – a lot of the small- and micro-caps p123 users often seek when modeling (with rank factors like MktCap lower is better and others similar to it that I* hate seeing). Excess supply of capital (the cause of low interest rates), like excess supply of anything, drives prices down and increases accessibility to the weakest buyers. Dividend stocks won;'t by ay means be alone when the Fed tailwind turns into a headwind.
Higher rates MUST hurt prices of fixed income (absent opportunities for credit upgrades, which don’t exist in the treasury part of the market). But dividends are not fixed. They can and often do rise, and the conditions that could push rates higher increase the likelihood of dividend hikes. This won’t impact that market in the first phase of rising rates since most investors weren’t old enough to understand the market (or even born) the last time rising rates were a fact of life. So it would be naive to expect them to connect the dots on day one. But as time passes and this generation of market participants learns from its own experience, things may change.
The great thing about dividends (and interest on fixed income) is that the cash can be reinvested to earn interest on interest and dividends on dividends. And as rates rise, the reinvestments act to continually average down (in contrast to the last 35 years, where those who reinvest have been averaging up for the most part). In the bond market, this is the concept of “duration” and the reason why high coupon premium bonds tend to be favored when investors fear rate increases (a bigger component of returns coming in the form of cash up front that can be quickly reinvested).Duration isn’t really a topic of conversation for stocks, but the mechanics (aside form maturity date) are largely applicable.
So there really are multiple layers to the relationship between a potential Fed headwind and dividend stocks. And in this world, it’s important that you avoid toxic backtests (those that stretch back over a long time with the red line shooting up at a 45+ degree angle). It would be better to test fo small challenging intervals and see how much less bad you can get your strategy to perform relative to benchmarks consisting of DVY, VIG or if you;'re into REITs, VQN.
