High yield beats high growth over 105 years

"February 09, 2005

How to beat the markets: invest in dull firms

By Patrick Hosking, Investment Editor

ECONOMISTS at the London Business School have come up with a "system" for beating the overall stock market that has worked for more than a century: pick boring stocks.

Dull companies with seemingly slow growth prospects have spectacularly outperformed racier-looking companies over the past 105 years.

A sum of £100 invested in 1900 in low-growth and therefore high-yielding shares would have grown to £6.9 million today, assuming no tax or dealing costs and all dividends reinvested. The same amount invested in high-growth, low-yielding companies would have grown to only £296,000 over the same period.

Even after adjusting for inflation, the boring stocks strategy would still have produced a 1,130-fold real return for the great-great-grandchildren of the original investor.

Paul Marsh, Professor of Finance, said that the trend had persisted on and off for the entire period and applied in other countries, too. "It?s compelling and intriguing and I wish I had a better explanation for it."

American academics Fama and French first identified the trend in the

1980s and argued that it was explained by the risk premium demanded of high yielders. Professor Marsh prefers the explanation that irrational exuberance has persistently persuaded investors to ignore the lessons of history and buy into high-growth stories.

"Growth is a very easy strategy for fund managers to explain to clients. But buy a dog that continues to be a dog and you risk just looking stupid."

In conjuction with ABN Amro, the LBS economists also published fresh research that found absolutely no evidence that fast-growing countries produced higher stock market returns than low-growth ones. Investors piling into China, India, Russia and Brazil might take note."

Reply to
Daytona
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You can't make a fair comparison between high growth and high income without taking tax into account.

Typically an investor would pay far less tax on investment returns through capital gains than through dividends, due to the high annual CGT allowance, ability to spread sales over a number of years, only selling when you need the money and so are probably in a lower tax band, etc.

Reply to
Andy Pandy

As a basic rate tax payer you pay no additional tax over and above the 10% witheld at source so effectively, as a single person, you have approximately a 35,000 per annum 10% tax band. The tax treatment of divis in the UK is pretty favourable and stacks up well against CGT.

- Julian

Reply to
Julian

Yes but it's not really "10% withheld at source", it's 30%.

The tax credit is a tax credit against some of the corporation tax paid by the company, which for large companies is 30%.

Before the government abolished ACT, the company would pay basic rate income tax on dividends and take this off their corporation tax bill. The government abolished ACT and replaced it with just a 10% tax credit on dividends - when the profits have actually been taxed at 30%. But at the same time they reduced the tax rate on dividends to 10% for basic rate taxpayers and 32.5% for higher rate tax payers.

The upshot of all this is dividends are really taxed at the corporation tax rate, ie 30%, for basic rate taxpayers (and non taxpayers too since they can no longer reclaim the tax credit). Higher rate taxpayers effectively pay 47.5%.

Not really. It's not just the rates, but the high CGT allowance and the ability to choose when you pay the CGT (if at all).

Reply to
Andy Pandy

And Capital Gains are effectively taxed at 30% as well in many cases.

The gains are either caused by retained profits (after paying 30% tax), increased expectation of future profits (discounted for the anticipated 30% tax bill on them), a reduction in the perceived risk in holding shares in the company, or a reduction in the required rate of return from equities generally. The last two aren't subject to Corporation Tax.

Reply to
Jonathan Bryce

Nor are the first two. The capital gain *per share* will be affected by corporation tax, but the capital gain *per pound invested* shouldn't be.

Because the capital gain is the difference between the purchase and selling price, so if the selling price is discounted because of the anticipated 30% tax bill on profits/retained profits, then so will the purchase price. A 10% rise or anticipated rise in profit before tax will result in a 10% rise in profit after tax, and so it should have the same effect on the *percentage change* in share price regardless of the level of corporation tax.

Reply to
Andy Pandy

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