“Dividend yield investment strategies in the Taiwan stock market” Chun-Fan You AUTHORS Szu-Hsien Lin Hsiao-Fen Hsiao Chun-Fan You, Szu-Hsien Lin and Hsiao-Fen Hsiao (2010). Dividend yield ARTICLE INFO investment strategies in the Taiwan stock market. Investment Management and Financial Innovations, 7(2-1) RELEASED ON Friday, 11 June 2010 JOURNAL "Investment Management and Financial Innovations" FOUNDER LLC “Consulting Publishing Company “Business Perspectives” NUMBER OF REFERENCES NUMBER OF FIGURES NUMBER OF TABLES 0 0 0 © The author(s) 2021. This publication is an open access article. businessperspectives.org Investment Management and Financial Innovations, Volume 7, Issue 2, 2010 Chun-Fan You (Taiwan), Szu-Hsien Lin (Taiwan), Hsiao-Fen Hsiao (Taiwan) Dividend yield investment strategies in the Taiwan stock market Abstract This study examines the feasibility of investment strategies based on dividend yields in the current stock dividend market. The data gathered from Taiwan listed companies from 2003 to 2007 shows that the performance of pure cash dividend yield portfolio investment during the second year proved significantly superior to those of market indices and a series of dividend yield portfolio. This result has two implications. First, the dividend yield ranking conveys a future profitability signal in the Taiwan market. Second, the behavior of investors manifests a sense of underreaction whereby response to the real value of the listed companies is gradually produced a few months after dividends have been de- clared. Finally, the empirical results are robust to the factors, such as: the 2008 financial storm, other definitions of dividend yield, various numbers of constituent firms, changes in portfolio weights, and consideration of transaction costs, etc. Keywords: dividend, dividend yield, trading strategies. JEL Classification: G11. Introduction© growth companies will prefer to use internally gen- erated cash to meet future investment demand. Such Recently, the adoption of trading strategies based companies will distribute stock dividend to substi- upon dividend yields has been raising issues of in- tute cash dividend. As a result, investors would pre- terest and importance in the field of financial man- fer stock dividends compared to cash dividends in agement. The view of “high dividend yields are terms of average except when prosperity starts to equivalent to high returns” also won the support of decline. The result suggests that most investors ac- the academic society1. For example, the study of knowledge that capital income is better than divi- McQueen, Sheilds, and Thorley (1997) showed that dend income. However, this assumes that investors the rate of return on dividend portfolios in the U.S. consider stock dividends as real dividends, not as is higher than the market indices. Also, the study stock splits2. To sum up, prior to investigating done by Visscher and Filbeck on Canada (2003) and whether “a high cash-dividend-yield portfolio is the research authored by Brzeszczy ski and Gajdka Ĕ equivalent to a high rate of return”, it is imperative (2007) on Poland confirmed the existence of the that all kinds of the portfolios of dividend yield be same phenomenon even in risk adjustments. How- surveyed. ever, these results are merely confined to cash divi- dends. In contrast, this study adopts dividend strate- Conforming to the possible dividend preference of gies under a diversified market to re-examine investors, this study therefore constructs various whether the investment strategies based on cash dividend yield portfolios. It must be clearly noted dividends do possess outstanding benefits. The ra- that stock dividends, or the combination of cash tionale behind this approach is that researchers are dividends and stock dividends are added apart from essentially acknowledging the fundamental proposi- the basic cash dividends. Empirically, these kinds of tion of the dividend-signaling hypothesis; that is, style investments are commonly seen in stock mar- that managers tend to increase their dividends, kets. According to Barberis and Shleifer (2003), thereby raising their dividend yields in order to con- investors often classify stocks as small cap dividend, vey a message of potential future profits. In particu- value stocks, technology stocks, public livelihood, lar, the dividends of those firms situated at the very and other concepts. For many investors, this method top of the dividend yield rankings are generally of classification does not only capture the informa- regarded as having greater information content than tion they need, but it also allows them to invest in those situated further down the rankings. accordance with their own investment habits. The underlying rationale is that they believe the per- Simply put, investors may also accept stock divi- dends except for cash dividends. The underlying rationale is that investors can identify the “Pecking 2 Strictly speaking, stock dividends do not in essence increase in value, Order” theory of Myers (1984), namely, high- but instead, they merely rearrange the composition of the owners’ equity accounts. However, some researchers propose different view- points, arguing that if future earnings growth does not make up for the reduction in retained earnings, not only will the subsequent distribution © Chun-Fan You, Szu-Hsien Lin, Hsiao-Fen Hsiao, 2010. of cash dividends be restricted, but the legitimacy of any future stock 1 In contrast, numerous literatures claim, “high dividend yield does not splits will also be questioned by outsiders (Grinblatt et al., 1984; mean high returns”. For example, Miller and Modigliani (1961) indicate Rankine and Stice, 1997a, 1997b). Based on this assumption, they that under the assumption of a perfect capital market, dividend policies contend that under a condition of asymmetric information, managers are irrelevant to the values of firms. Moreover, Filbeck and Visscher will disclose private information by the distribution of stock dividends (1997) and Ap Gwilym, Seaton, and Thomas (2005) could not find a (particularly those distributed from retained earnings) in order to convey favorable sequence for dividend portfolios in the British market. a better future outlook for the firm’s performance. 189 Investment Management and Financial Innovations, Volume 7, Issue 2, 2010 formances of these style investments will be supe- the “Winner Day” concept; that is, it computes the rior to those of market indices. Likewise, investors number of days in which the daily-accumulated with specific preferences also believe that the rank- returns are higher than those of market indices dur- ing of dividend yields may reveal the information ing the investment period. Due to the financial content of future profitability. changes in 2008, we believe that investors have intensified their requirements in terms of risk expo- In a narrow sense, the information content of divi- sure. Specifically, investors do not only pay atten- dends refers to dividend changes or dividend growth tion to the final rate of return during the investment rate. As such, in assuming that investors trust the period but also take note of daily changes in stock stock information they receive, the above-mentioned prices because more than just directly affecting their definitions can also serve as indicators in selecting work attitude, this information directly influences stocks. Empirically, Aharony and Dotan (1994) and their investment confidence in the future. Second, in other scholars have long discovered that the greater calculating the rate of return, this study adopts the the magnitude of dividend changes, the higher un- unadjusted stock prices that investors are most fa- expected profits in the next period. Thus, this study miliar to calculate capital gains, in addition to the shall incorporate this particular point and examine dividends during the investment period. This whether investment strategies are capable of sur- method is the most transparent of all and even non- passing the general dividend yield portfolios. seasoned investors can testify to this fact. When examining dividend yield portfolios, some Based on the actual market practices stated above, researchers ignore the returns on low dividend yield the result of this study indicates that the perform- portfolios. According to Graham and Kumar (2006), ance of dividend yield portfolios is better than that most investors who prefer high dividend yield are of market indices – Taiwan’s Weighted Price Index. older individuals with lower income. In contrast, In addition, it also has the following advantages: those who prefer low dividend yields are institu- First, the structural process of portfolios is fairly tional investors and the young ones. Say for instance transparent and occurs only once a year, thereby the investment returns of investors are higher than saving a lot of working time. Second, the cost is those of senior citizens, and then the return on “low substantially low since transactions are held only dividend yield” portfolio may exceed the “high once a year. Third, the average return rate is higher dividend yield” portfolio. Thus, before making an than market indices and the Beta value is lower than in-depth analysis, we also need to confirm if the 1, thereby delivering a superior mean-variance per- difference in the returns between the two types of formance. As a whole, the merits of the dividend investors conform to the expectations of white- yield portfolio in this study resemble that of Fun- haired investors. damental Index (Arnott, Hsu, and Moore, 2005)1 Finally, in screening the constituent firms, some although this indicator is actually used in large- literature contends that dividend yields with the scale funds. In contrast, the dividend yield portfo- addition of other variables are superior to dividend lios in this research cater to the needs of small yields alone. For example, Koch and Sun (2004) funds. Therefore, the main contribution of this show that the addition of earnings changes to divi- research is to provide a useful reference on divi- dend changes is more likely to capture the reaction dend-yield-based mutual funds to other countries, of markets upon dividend signaling.