M&M Redux

As a dividend investor in a stock market, I usually find myself having to make my case as a distinctly minority approach to the stock market. Dividend-focused investing has been out of favor for decades, with an academic tradition leaning against a cash-based relationship to stock ownership dating back to 1961. Sometimes, however, the anti-dividend narrative comes in a form that is so crisp, clear, and well-argued that it serves equally well as a platform for pointing out why investors might consider the opposite approach…

Managers of a quantitative investment strategy recently published a compelling piece showing that the dividend “factor” is simply a manifestation of more basic underlying factors that have been used to manage portfolios for decades.[1] Sifting through reams of data on the characteristics of stocks that drive superior total return, Yin Chen and Roni Israelov demonstrate convincingly that the dividend factor itself is mostly a reflection of other, underlying, and more important stock market characteristics. They conclude, “after controlling for value, quality, and defensive factors, the excess return of high-dividend over low-dividend turns negative. In other words, our analysis suggests that investors who seek to achieve alpha should invest directly in a combination of these factors instead of holding high-dividend stocks…. All things considered, the dividend yield is just a poor proxy for a value, quality, and defensive-based multi-factor strategy.”  For sophisticated stock market investors able to appreciate large data-based analyses and manage complex investment strategies, their conclusion is very suggestive about past market dynamics and possibly future ones. Indeed, if looking for a stock market characteristic of diminishing utility over the past forty years of falling rates, dividend yield would rightly have been near the top of anyone’s list.

But the implications of their well-researched and well-presented analysis go beyond their main conclusion. The piece struck me in some ways as a bookend for, or a modernized version of, M&M, 1961–Miller & Modigliani’s famous, dividend payout ratio irrelevance argument. Rather than sharing M&M’s concern about the packaging of productive assets due to different capital structures or payout policies, however, the authors in this case use the stock market “factors” of F&F, Eugene Fama & Kenneth French, originally published in the early 1990s. (Their original factors were market sensitivity, relative size, and relative value; F&F later added profitability and investment to create a five-factor model.) In the decades since the emergence of factor investing, hundreds of other factors have been developed to slice and dice stock market returns. Coming from a different perspective than the Nobel prize winners, Chen & Israelov arrive at similar conclusions. Notably, the broader market contexts are quite different: a 1950s-1960s capital intensive economy and a 2020s “factor” intensive stock market. Standing M&M next to Chen & Israelov’s invocation of F&F creates an elegant symmetry of irrelevance, over an extended period, suggesting to investors that dividends simply don’t matter very much—neither as payout policy in the 1960s or as a factor in the 2020s—and should not be a material (or possibly even an immaterial) part of the investment equation.

The clarity of their argument does not invite a substantive rebuttal—that would be pointless—but a strong contrast. It really comes down to the investor’s perspective and intent. The authors’ perspective is crystal clear: If the investor had been in the stock market to generate relative total return and had the means to implement large-scale quantitative protocols, their analysis about dividend yield over the past half-century is indisputable. Ignore it at your peril.

In contrast, committed dividend investors approach the market from a quite different vantage point, one based on the philosophy of business ownership through the stock market. From that perspective, several fundamental distinctions emerge from the traditional buy-low-sell-high approach. The first is how the total return sought by all investors is generated. Across the decades, both M&M and the current authors using F&F assume—consistent with academic finance—that a realized or an unrealized capital gain is identical to an income payment. That’s the stock market standard, and in the calculation of total return, the two metrics are treated equally. But as a dividend investor in a stock market, and as argued at length in the forthcoming Ownership Dividend, I take a different view. While selling an asset (or seeing green on the screen) and getting a check in the mail from an ongoing enterprise may be identical on a classroom chalkboard, that’s just not so outside the academy. One is the result of a marketplace transaction; the other is the consequence of a successful, on-going, enterprise. The difference is a matter of philosophy, not math. True, the past few decades have favored harvested capital gains (rather than dividends) to fund consumption—so bully for the bold–but that does not make the two forms of return the same.

Secondly, both M&M’s analysis and those based on the F&F factors express no interest whatsoever in the notion of direct business ownership or the challenge of being a minority investor of large-scale corporations within an agency framework. Here too, the philosophical difference between being a stock market investor and a business owner through the stock market could not be greater. As a long-term investor, I may own shares in the Coca-Cola corporation because I want to have a stake in a successful, reasonably steady, and cash-distributive business. Owning a portion of the net assets of a named enterprise for its long-term income stream, and identifying as a minority owner of said business, is a far cry from temporarily renting baskets of nameless CUSIPs for their factor traits. Both are valid pursuits, but they bear little resemblance to one another.

Chen & Israelov’s analysis is a fine work for understanding the interplay of dividend yield and other traditional “factors” within a stock market context. At the end of the day, however, it comes down to what the investor wants from the exercise: business ownership through the capital markets or temporarily holding stocks for their factors. The great attraction of our system is that it makes both opportunities available.


[1] Yin Chen and Roni Israelov, “Income Illusions: Challenging the High Yield Stock Narrative,” (June 2023)