Surprise! Higher dividends = higher earnings growth

How dividends can signal better prospects for Insurance Australia Group Ltd (ASX:IAG) and QBE Insurance Group Ltd (ASX:QBE).

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

'Surprise! Higher dividends = higher earnings growth'.

That is the fascinating title of a 2003 study by Robert Arnott and Clifford Asness which found that companies paying out a higher percentage of their profits are aligned with higher earnings growth! (The full study, in all its glory, can be read here.)

It sounds counter-intuitive, as the authors themselves note. Shouldn't companies with lower payout ratios have more money to reinvest back into their business and grow at a faster rate?

The reinvestment riddle

That may be true of many young 'growth' companies which need the cash early on to fund the opportunity at hand. But Arnott and Asness looked at decades of data and found a strong relationship between the payout ratio of U.S. equities and future earnings growth.

The cause, they believe, is that managers use dividend payout rates to signal their optimism that the future dividend will not need to be cut due to future earnings growth.

Arnott and Asness also proposed that companies with low payout ratios, and thus more cash to invest, may not be using the money (your money!) effectively for growth. Instead they waste it on "inefficient empire building and the funding of less-than-ideal projects and investments" which result in poor subsequent growth.

Case study: QBE Insurance

Shareholders of QBE Insurance Group Ltd (ASX: QBE) may certainly agree. After dozens of acquisitions under departed CEO Frank O'Halloran, QBE suffered years of earnings retrenchment, when value failed to materialise and acquisitions began dragging the 'empire' down like dead-weights.

Only in the last 12 months have earnings started to show signs of promise, allowing directors to raise the maximum dividend pay-out ratio from 50% to 65% of cash profits (effective October 2016), which per Arnott and Asness could be a positive sign for earnings.

It could be a similarly rosy picture for Insurance Australia Group Ltd (ASX: IAG), which has also increased its dividend payout ratio for 2016. The company expects to pay out between 60% and 80% of full year cash earnings in 2016, up from between 50% and 70% in 2015.

Motley Fool contributor Regan Pearson owns shares of QBE Insurance Group Ltd.. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »