Jesper O. Madsen, CFA
Portfolio Manager

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Included in this issue:
Since investors often turn to Asia looking for growth, they may overlook that the region offers a well-diversified universe of dividend-paying companies in terms of sectors and countries. This month Jesper Madsen revisits the notion that the Asia Pacific region should play an essential role for investors seeking yield and growth in income.

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"Since investors turn to Asia looking for growth, they often end up overpaying for it."

A Stock for its Dividends—Revisited

“Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore, we must say that a stock derives its value from its dividend, not its earnings. In short, a stock is worth only what you can get out of it. Even so spoke the old farmer to his son: A cow for her milk/ A hen for her eggs/ And a stock, by heck/ For her dividends.”

John Burr Williams, “The Theory of Investment Value” (1938)

In late 2006, Asian markets were in the later stages of a bull run and few could see the value in the basic tenets laid out by economist John Burr Williams. We wrote about Asia’s particular potential for dividend-focused investors at that time in our November 2006 issue of Asia Insight. Investors in Asian equities back then generally gave little thought to dividends. And really why should they have? Most of their returns during the few years preceding 2007 had come from capital appreciation. The interest in dividends increased as ongoing capital appreciation became harder to achieve in the years that followed the 2007 market peak. With low yields on alternative investments, such as fixed income securities, investors have turned to higher yielding equities to meet their needs for both income and growth in income. Fortunately, the case for investing in Asian dividend-paying companies to achieve this remains, and if anything, has strengthened since 2006.

The last five years also taught investors that while capital appreciation and dividends are both part of total return, they are not equally robust. Dividends are paid out and are absolute and realized value. Capital appreciation, on the other hand, is often unrealized, and can quickly evaporate, as was made painfully apparent during the recent financial crisis. Furthermore, unlike asset values that tend to fluctuate significantly, dividend income from a diversified portfolio tends to exhibit stability, given the low probability of an across-the-board cut in dividends. A subtle, yet important, point—being able to de-risk the long-term return profile by taking a meaningful portion in hand via the dividend, can differentiate investors. It is no longer necessary to chase companies that are perceived to deliver high rates of earnings growth. These recognized “growth” companies often sell at expensive valuations in Asia, posing a risk to investors’ capital should elevated expectations not be met.

Investors most often look for growth strategies when allocating to Asia. But dividend-focused strategies have actually performed well in the region over longer periods. Various quantitative research studies clearly show that over longer periods higher-yielding equities have delivered significantly higher returns than lower-yielding equities (see chart below). Focusing on moderate dividend growth over this period was also shown to be an effective strategy. Capital appreciation is often viewed as separate from income. However, as John Burr Williams reminds us, if a stock is for its dividend, then capital appreciation over longer periods will be driven by the growth in dividends.


The universe used is the S&P Broad Market Index for Asia Pacific ex Japan. For dividend yield and EPS growth factors, companies are ranked monthly by percentile and divided into quintiles.

Interestingly, a strategy of investing in the companies that had delivered the fastest 12 months trailing growth in earnings turned out to be a relatively poor option when investing in Asia. The explanation for this seems fairly simple. Since investors turn to Asia looking for growth, they often end up overpaying for it, resulting in mediocre long-term returns. A focus instead on more moderate, but often more sustainable levels of earnings growth was a more profitable strategy.

Overpaying for Growth

It is not just investors that overpay for growth, management teams often do so as well. One of the main objections to paying dividends is the notion that companies can invest the cash at better returns than investors. While that may indeed be true in some cases, few companies can successfully do so over longer periods. One (albeit simplistic) measure of this is the relationship between payout ratios and return on invested capital (ROIC). The role of company management should be one of stewardship of shareholder capital, (i.e. generating attractive return on retained earnings). One would intuitively expect companies that retain more of their earnings for reinvestment to also generate higher returns on that retained capital invested. However, based on our research of rolling, three-year ROIC, we found that the quartile of companies that retained the most earnings actually generated significantly lower ROIC, compared to the quartile of companies with the highest payout ratios. However, this is not a surprising finding given how difficult it is for companies to sustain the competitive edge needed to give them the ability to continuously invest capital in high-return growth opportunities. Putting management on a capital diet is therefore one of the best ways for shareholders to lower the risk of companies engaging in value-destroying acquisitions and investments. So while there are exceptions to the rule, on average, companies that pay out a larger portion of earnings tend to exhibit better stewardship.

A track record of dividend payments can also help raise the corporate governance profile of a company and give greater assurance regarding reported earnings. If an ongoing dividend is paid, the cash flow to support it must have been generated (unless the company has raised equity or debt to fill the gap). Of the 20 or so U.S.-listed reverse mergers that were embroiled in corporate governance scandals in 2010, none paid a dividend. This is not to say that investing with dividend paying companies is a bullet proof way to avoid scandals, but it does seem to raise the overall quality of a portfolio of companies in terms of corporate governance.

Taking Dividends Seriously

There is, therefore, good reason for long-term investors to take dividends seriously when allocating to Asia. Over the last 10 years, 40% of the total return of the MSCI Asia Pacific Index was derived from reinvested dividends. The main questions facing investors then are: How much do I have to pay for dividends in Asia? What is the dividend growth rate and what is the scale of the universe of dividend-paying companies?

Asian companies have a solid track record when it comes to dividend payments. About 95% of companies in the MSCI Asia Pacific Index pay a dividend, compared to just about 60% for the S&P 1500 Index. Asian companies not only exhibit a high propensity to pay dividends, they also have a proven track record of commitment to paying the dividend, even during tough times. Dividend policies were adhered to, even during the global financial crisis, when dividends for the MSCI Asia Pacific constituents fell roughly 15% even though reported earnings more than halved. The reason for this boils down to the ability and willingness of these companies to pay dividends. The ability of companies in Asia is good, especially when compared to history. Before the Asian Financial Crisis in 1997-98, Asian companies were net consumers of capital, investing more than they earned. The gap was filled in many cases with debt, much of it foreign, eventually triggering the Asian Financial Crisis. The crisis scarred many management teams as they teetered on the brink of bankruptcy, prompting them to reduce their capital intensity. Today, capital expenditure accounts for 10% of sales or about half of what it was in 1997. Companies have instead become capital generators, allowing them to steadily pay down debt. Net debt-to-equity today is less than 30% compared to about 80% in 1998. The high degree of willingness to pay dividends can in large part be explained by the concentrated shareholding structure of many companies in Asia. Majority shareholders, such as entrepreneurs, founding families, conglomerates and governments, all view the dividend as a steady income source, explaining the lower volatility of dividends relative to earnings.



Asia Pacific offers a well-diversified universe of dividend-paying companies, reducing the reliance on any one country or sector (see chart above). This is important from a portfolio construction perspective, since it enables investors to collect dividends from more than a dozen different currencies and countries in various stages of economic development. There are about 1,500 dividend-paying companies in Asia Pacific with a dividend yield in excess of 2% and a market capitalization greater than US$500 million. Dividend payments from Asia have experienced rapid expansion, both due to organic growth as well as initial public offerings. Between 2002 and 2010, companies organically grew dividends by 17% in U.S. dollar terms, compared to 6% for the S&P 500 Index over the same period (see chart below). The constituents of the MSCI Asia Pacific Index paid US$219 billion in 2010 to shareholders compared to US$59 billion in 2002. This was in large part due to companies that were listed during this period, especially boosting the dividends paid by Chinese companies. To underscore how significantly this has altered the makeup of the universe, approximately 70% of all the dividends paid out by Hong Kong-listed companies were from companies that were not even listed back in 1998. Today, three of the top 10 highest dividend payers in Asia Pacific are Chinese. China’s A-share market is still largely unavailable to most foreign investors. If dividends paid to the holders of A-shares are included, half of the top 10 dividend payers are Chinese. As a result, China/Hong Kong companies account for 23% of dividend payments in the region, a stark change from 1998 when Chinese companies were barely represented. Importantly though, as can be seen from the Dividend Payments chart, investors are not held hostage to any single country or sector when pursuing a dividend-focused investment strategy.



We believe that Asian dividend payments should be sustainable going forward given the low debt-to-equity, moderate payout ratios for the market and a proven willingness to pay dividends. Longer-term dividend growth will depend on nominal earnings growth of companies in Asia. Yields remain higher in Asia compared to the U.S., even though the region has delivered significantly faster dividend growth from a diverse set of companies and countries. Given these attractive fundamentals, we think Asia should play an essential role for investors looking for yield and growth in income.

Jesper Madsen, CFA 
Portfolio Manager
Matthews International Capital Management, LLC