Quantitative Analysis of Dividend Yield and Company Size in Industrial Sector.

1. Quantitative Analysis of Dividend Yield and Company Size in Industrial Sector
By Jyoti Chetri
April 6, 2014
Introduction
Sitting on cash is an expensive affair to the management of the company because there is an
opportunity cost attached to it. An inflated cash balance can also signal that the company is not able to
put the cash to productive use due to a lack of investment opportunities or growth ideas. High cash
sitting on the balance sheet may lead the management to make poor business decisions.
Companies have many choices of what to do with the cash that they generate. Common decisions
include making acquisitions, investing in internal projects, paying down debt, repurchasing stock, or
paying out dividends. The underlying benefit of a high cash balance is that it gives a company funding
resources to grow and reward shareholders without the requirement of new debt or equity.
If the management determines that its business is growing fast and it has excess cash available, it's
logical for management to pay a dividend to shareholders. A corporation can have a good reason for
taking on debt, such as funding a strategic acquisition. However, depending on the individual company,
it's important to never let the debt reach a level that becomes unmanageable.
The industrial sector is very sensitive to the global economy. These companies are often well positioned
to take advantage of economic growth opportunities. In times of slow growth, they are likely to have
plenty of internal costs to cut to improve the bottom line, and hopefully cash on hand to make
acquisitions in preparation for better stages of the economic cycle.
Data
Data was extracted from the FactSet Fundamentals global database from 12/30/1994 to 12/31/2013.
This period includes several economic and market cycles. The analysis was completed by running the
data in FactSet Alpha Testing software. Equity securities of the industrial sector with market
capitalizations greater than $100 million were included.
Company returns were rebalanced quarterly into five fractiles based on dividend yield and net sales.
Dividend yield was calculated as annual dividends divided by the current price at the time. Equal‐
weighted future returns for each fractile and the universe were computed for three, six, twelve, twenty‐
four and thirty‐six month periods. To examine size of companies, net sales was used, and we also
examined other factors related to size including total debt, total capital expenditure, and total assets
which all yielded very similar results about the effect of company size.
The research provides a standardized report on factor behavior for the quarter to quarter periods. We
provided brief comments highlighting important and interesting trends in factor behavior.
High Dividend Yield
Companies in the industrial sector with the highest dividend yield (Fractile 1) outperform other stocks by
a large margin, as shown in Figure 1. Outperformance may be due to how high dividend paying stocks

2. impose more discipline on management as to how they allocate the cash, or perhaps for the simple
reason that investors relate high dividends with a quality, successful company. However, during financial
uncertainty, Fractile 1 equities are susceptible to underperformance like their peers. This can be seen in
the significant drop of Fractile 1 shown in the graph during the financial crisis of 2008.
Fractile 1 stocks have significantly higher volatility (measured by standard deviation), but the
outperformance they return will probably justify the added risk. Furthermore, Fractile 2 (second highest
dividend yield) and Fractile 5 (lowest dividend yield) quintiles have similar returns and placed after
Fractile 1.
Figure 2 illustrates that high yield stocks outperform the universe during one and two year time
horizons, while the only significant underperformance occurring during the financial crisis. Figure 2’s
table shows that high dividend yield stocks outperform on average during both up and down markets.
Fractile 1 outperforms more often during down markets (outperforms 95% of time) than up markets
(outperforms 82% of time). Perhaps this is due to dividends being seen as a less risky investment during
down markets.
Figure 1. Growth of $1 from 12/30/1994 to 12/31/2013
High yield
dividend
stocks produce
much higher
returns than
low dividend
yield stocks,
in addition to
outperforming
the universe
Universe 16.41 31.1% 1.19 4.60
Fractile 1 (High Yield) 28.70 40.7% 1.13 1.53 0.97 11.56
Fractile 2 16.36 27.2% 0.83 1.34 -0.17 5.73
Fractile 3 12.18 28.0% 0.89 0.88 -0.97 3.74
Fractile 4 7.64 30.4% 0.99 0.53 -1.58 1.88
Fractile 5 (Low yield) 16.45 35.8% 1.16 1.01 0.03 0.12
Period: 12/30/1994 to 12/31/2013, 12 month returns, Universe: equity securities with over $100 million
market capitalization, Rebalancing: every 3 months, Weighting: equal-weighted returns
Median
YieldFractile
12-Month
Returns
Standard
Deviation Beta
Sharpe
Ratio
Information
Ratio
0
20
40
60
80
100
120
140
160
180
1994
1995
1996
1997
1998
1999
1999
2000
2001
2002
2003
2004
2004
2005
2006
2007
2008
2009
2009
2010
2011
2012
2013
Universe Return
1 (Highest Yield)
2
3
4
5 (Lowest Yield)

3.
Figure 2. Excess Returns from High Dividend Yield Over Time
Category
Number of Quarterly Periods
Percent of Respective
Periods
Up Markets 57 75.00%
Down Markets 19 25.00%
Fractile 1 Outperforms 65 85.53%
Fractile 1 Underperforms 11 14.47%
Up Market & 1 Outperform 47 82.46%
Up Market & 1 Underperform 10 17.54%
Down Market & 1 Outperforms 18 94.74%
Down Market & 1 Underperforms 1 5.26%
The graphs show returns of Fractile 1 less the returns of the universe over 12 and
24 month holding periods. The table shows the efficacy of high dividend yield
during up and down markets.
‐40%
0%
40%
80%
120%
160%
1994
1995
1996
1997
1997
1998
1999
2000
2000
2001
2002
2003
2003
2004
2005
2006
2006
2007
2008
2009
2009
2010
2011
2012
2012
12‐Months Excess Returns (1's Universe)
‐40%
10%
60%
110%
160%
210%
260%
1994
1995
1996
1996
1997
1998
1998
1999
2000
2000
2001
2002
2002
2003
2004
2004
2005
2006
2006
2007
2008
2008
2009
2010
2010
2011
24‐Months Excess Returns (1's Universe)

4. Figure 3 presents the excess returns of the top two Fractiles of high dividend yield stocks compared to
the universe for one and two year periods. Fractile 1 nearly always has excess returns over the universe
in both time horizons while Fractile 2 underperforms the universe in the one year period, and essentially
matches the universe return over two years. This shows that the highest dividend stocks have a
significant advantage to even the second fractile of high dividend paying industrial companies.
Company Size
The data for company size doesn’t say how to utilize cash balances, but the results are thought‐
provoking. We divided firms based on net sales into quintiles. As most investors would guess, the
quintile with the smallest companies (Fractile 5) has higher average returns than their peers and the
universe. Fractile 4, the next smallest companies, has the next highest returns and the universe comes
slightly behind that quintile.
Investors would probably expect that the higher return comes as a trade off with much higher risk, but
interestingly, the standard deviation for Fractile 5 is 24%, while the three fractiles with the largest
companies have about 20% each. Only 4% more standard deviation for about twice the average returns
is attractive for many investors.
Figure 3:Highest Dividend Yield Companies Earn Excess Returns over Universe
97%
49%
99%
52%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
1's (12mo) 2's (12mo) 1's (24mo) 2's (24mo)
Excess Return over Universe
Hit Rate: Percent Months Return > Universe

5.
Figure 5’s shows that over both one and two year time horizons, the smallest industrial companies most
of the time with the only exceptions being during times of financial instability.
The table in Figure 5 conveys that the Fractile 5’s companies outperform about two thirds of the time,
and only slightly more often during up markets and slightly less often during down markets. Smaller
companies may have higher growth than larger firms, so returns may not be as driven my systematic
exposure to the market and more driven by the individual firms' business momentum.
Figure 4. Growth of $1 from 12/30/1994 to 12/31/2013
The smallest
industrial companies
have significantly
greater returns than
larger companies
and also outperform
the universe
Universe 16.51 31.1% 0.83
Fractile 1 (Largest Companies) 12.21 19.2% 0.92 0.64 -0.77
Fractile 2 12.83 19.9% 0.97 0.64 -0.83
Fractile 3 14.62 19.9% 0.97 0.73 -0.44
Fractile 4 17.36 21.6% 1.06 0.80 0.23
Fractile 5 (Smallest Companies) 24.79 24.3% 1.08 1.02 0.75
Period: 12/30/1994 to 12/31/2013, 12 month returns, Universe: equity securities with over $100 million
market capitalization, Rebalancing: every 3 months, Weighting: equal-weighted returns
Fractile
12-Month
Return
Standard
Deviation Beta Sharpe Ratio Information Ratio
0
10
20
30
40
50
60
70
80
90 1994
1995
1996
1997
1997
1998
1999
2000
2000
2001
2002
2003
2003
2004
2005
2006
2006
2007
2008
2009
2009
2010
2011
2012
2012
2013
Universe Return
1 (Highest Net Sales)
2
3
4
5 (Lowest Net Sales)

6.
Figure 5. Excess Returns from Smallest Companies Over Time
Category
Number of Quarterly
Periods
Percent of Respective Periods
Up Markets 57 75%
Down Markets 19 25%
Fractile 5 Outperforms 51 67%
Fractile 5 Underperforms 25 33%
Up Market & 5 Outperforms 39 68%
Up Market & 5 Underperforms 18 32%
Down Market & 5 Outperforms 12 63%
Down Market & 5 Underperforms 7 37%
The graphs show returns of Fractile 5 less the returns of the universe over 12 and
24 month holding periods. The table shows the efficacy of being a small company
during up and down markets.
‐40%
‐20%
0%
20%
40%
60%
80%
100% 1994
1995
1996
1997
1997
1998
1999
2000
2000
2001
2002
2003
2003
2004
2005
2006
2006
2007
2008
2009
2009
2010
2011
2012
2012
12‐Months Excess Returns (5's Universe)
‐40%
0%
40%
80%
120%
160%
1994
1995
1996
1996
1997
1998
1998
1999
2000
2000
2001
2002
2002
2003
2004
2004
2005
2006
2006
2007
2008
2008
2009
2010
2010
2011
24‐Months Excess Returns (5's Universe)

7. Figure 6 shows that the smallest companies (Fractile 5) outperform the universe significantly more often
than the next smallest companies (Fractile 4) in both one and two year periods. Additionally, the excess
return is much higher for Fractile 5 than Fractile 4.
Improving the Model
Looking at dividend yield in relation to return is a good idea and can help lead to decisions about where
to use a company’s cash. However, there are many more factors to consider for usage of cash including
capital expenditure, paying down debt, and share buybacks. The data shows that companies with high
dividend yield excess stock returns. This doesn’t mean that every industrial company should try to move
into the highest yielding fractile as quickly as possible. For example, a company may not be able to
sustain a higher dividend yield for multiple reasons, and in those circumstances a large jump into Fractile
1 dividend yield could be disadvantageous. The intelligent executive must consider all aspects and
factors and not simply believe returns will improve because his or her firm moved into the favorable
fractiles.
My findings suggest that the smallest companies outperform their peers should not be viewed as advice
that investors should buy only small industrial stocks. It is first necessary to consider the investor’s goals.
Investors must consider the stock’s higher standard deviation of returns and their underperformance
about a third of the time, regardless of whether it is an up or down market. One should also consider
why small companies have outperformed large firms. Only then should the data be utilized as a
guideline for investing in industrial stocks of different size.
Figure 6: Smallest Industrial Companies Earn Excess Returns over Universe
80%
53%
86%
56%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
5's (12mo) 4's (12mo) 5's (24mo) 4's (24mo)
Excess Return over Universe
Hit Rate: Percent Months Return > Universe