Dividend levels (not changes) signal future earnings

Abstract

We provide empirical evidence that the level of the dividend signals long-horizon future earnings and that the earnings information embedded in the dividend has implications for expected returns. From an earnings information perspective, we show the level of the dividend is associated with up to five-year ahead earnings, incremental to earnings releases after the dividend declaration. The dividend change has minimal incremental information relative to that in the level. Dividend levels have a larger association with future earnings when recent returns are negative, consistent with the dividends providing information about sustainable cash flows rather than earnings growth. From the perspective of returns, we show returns are increasing in the future earnings yield predicted by the dividend level. Consistent with dividends providing a signal of long-term value, we show returns for dividend payers are more transient, resulting in higher returns to short-term reversal strategies and lower returns to momentum strategies. Collectively, our results suggest that dividend levels signal earnings information to market participants and, as a result, help explain the firm choice to pay persistent dividends.

Keywords: dividends, information environment, signaling, earnings

JEL Classification: M40, M41, G30, G32, G35