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We investigate whether dividend policy, as observed in the payout ratio of the U.S. equity market portfolio, forecasts future aggregate earnings growth. The historical evidence strongly suggests that expected future earnings growth is fastest when current payout ratios are high and slowest when payout ratios are low. This relationship is not subsumed by other factors, such as simple mean reversion in earnings. Our evidence thus contradicts the views of many who believe that substantial reinvestment of retained earnings will fuel faster future earnings growth. Rather, it is consistent with anecdotal tales about managers signaling their earnings expectations through dividends or engaging, at times, in inefficient empire building. Our findings offer a challenge to market observers who see the low dividend payouts of recent times as a sign of strong future earnings to come.

About the Author(s)

Robert D. Arnott

Rob Arnott is chairman and CEO at Research Affiliates, LLC. He pioneered several portfolio strategies that are now widely used, including tactical asset allocation, global tactical asset allocation, tax-advantaged equity management, and the Fundamental Index® approach to indexation. Previously, Mr. Arnott served as chairman at First Quadrant, LP; as global equity strategist at Salomon Brothers; as founding president and CEO at TSA Capital Management (now part of Analytic Investors, LLC); and as vice president at The Boston Company. He is a frequent contributor to financial journals and books and is the co-author of The Fundamental Index: A Better Way to Invest. Mr. Arnott has published in such journals as the Journal of Portfolio Management, the Harvard Business Review, and the Financial Analysts Journal, where he also served as editor. He has received five Graham and Dodd Scroll Awards from the Financial Analysts Journal and two Bernstein Fabozzi/Jacobs Levy Awards from the Journal of Portfolio Management. Mr. Arnott holds a degree in economics, applied mathematics, and computer science from the University of California, Santa Barbara.

Clifford Asness
Clifford S. Asness

Clifford S. Asness is managing and founding principal at AQR Capital Management LLC. Previously, he was managing director and a director of quantitative research for the asset management division at Goldman Sachs. Dr. Asness serves on the editorial boards of the Journal of Portfolio Management and the Financial Analysts Journal and the governing board of the Courant Institute of Mathematical Finance at New York University. He has received the James R. Vertin Award from the Research Foundation of CFA Institute for producing a body of research notable for its relevance and enduring value to investment professionals in addition to other awards given for his written articles. Dr. Asness holds a BS from the Wharton School at the University of Pennsylvania, a BS from the Moore School of Electrical Engineering, and an MBA and a PhD from the University of Chicago.