The Relationship between Dividend Payout and Price to Earnings
28 Pages Posted: 10 Aug 2017 Last revised: 16 Oct 2017
Date Written: August 9, 2017
Using a large database of all S&P 1500 index firms spanning a 88-quarter period from 1995 through 2016, we document that current period dividend payout is significantly and positively correlated with next period Price-to-Earnings ratio (PE) for high market cap firms and manufacturing firms, and significantly negatively correlated for high book-to-market firms. Market cap (firm size), book-to-market ratio (a proxy for market perception of growth potential) and industry matter for determining PE levels as a function of payout levels. However, once the PE levels are determined, current period dividend payout change is significantly and negatively associated with next period PE change. We find evidence supporting an argument that an increase in current period payout signals reduced investment opportunities and increased risk that reduce future PE ratios. Thus, modeling determinants of PE must take into account industry, size, risk and market perception of growth potential for a firm.
Keywords: Price-to-Earnings ratio, PE ratio, dividend payout ratio, industry, market cap, firm size, book-to-market ratio, growth opportunities, firm risk
JEL Classification: G35
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