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Growth options, dividend payout ratios and stock returns

George Li (Department of Finance, San Francisco State University, San Francisco, California, USA)

Studies in Economics and Finance

ISSN: 1086-7376

Article publication date: 3 October 2016

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Abstract

Purpose

This paper aims to examine the impact of the dividend payout ratio on future stock returns and momentum strategies.

Design/methodology/approach

The author uses the portfolio sorting approach used in the momentum literature to examine this impact.

Findings

First, the author shows that the returns for the winner stocks tend to be the largest if no dividends are paid and then decrease with the dividend payout ratio; the returns for the loser stocks tend to have an inverted U-shaped relationship with the dividend payout ratio, but the zero-dividend loser stocks have the smallest return; and the returns for the stocks between the winners and the losers tend to remain similar, regardless of the dividend payout ratio. Second, the author shows that momentum profit is the largest for the stocks that do not make dividend payment but appear similar for the stocks that pay dividends. The author's empirical findings imply that stock price momentum is a function of the dividend payout ratio, growth stock momentum tends to be much stronger than value stock momentum and no-dividend stock momentum beats dividend stock momentum. In fact, when the dividend payout ratio is considered, momentum profit can be improved by up to 63 per cent.

Originality/value

This paper is the first one to examine the impact of dividend payout ratios on future stock returns and momentum profit, and it obtained many interesting empirical results. In addition, unlike most studies in the momentum literature that use behavioral theory to explain empirical findings, this paper uses the growth option idea to present a rational explanation for the empirical results in this paper.

Keywords

Acknowledgements

The author would like to thank colleague Donglin Li for helping to run the data. All errors are those of the author.

Citation

Li, G. (2016), "Growth options, dividend payout ratios and stock returns", Studies in Economics and Finance, Vol. 33 No. 4, pp. 638-659. https://doi.org/10.1108/SEF-08-2015-0195

Publisher

:

Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

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