Emerging Market Dividend Paying Companies Less Risky

23 Jun, 2015 by Dwarka Lakhan

Investing in dividend paying emerging market (EM) stocks for greater total returns is a whole lot more attractive than investing in dividend paying developed market (DM) stocks and non dividend payers.

And that’s not all – EM companies that pay dividends are diversified across a wide range of sectors and are relatively less risky than their non dividend-paying counterparts, making them ideal investments as EMs mature.

These are the findings of a groundbreaking study, A Field Guide to Emerging Market Dividends, published by S&P Dow Jones Indices (Qing Li and Aye M. Soe) in April 2015.

The surprising results of the study which analyzed data for the 16-year period December 31, 1998 to December 31, 2014, found that:

More EM companies pay dividends than DM companies

Over the past 16 years, the percentage of companies paying dividends in emerging markets has increased steadily from about 60% in 1998 to between 70% and 80% in 2014. Over the same period, dividend payers in developed markets varied between 60% and 70%.

EM companies have a higher payout ratio than DM companies

The aggregate annual dividend payout ratio in EMs has been rising, while the percentage of earnings paid out to shareholders in DMs has been declining.

EM dividend-payers have greater returns; less risky than non-dividend payer

Dividend payers in EMs posted an average annual return of 15.79%, with a Sharpe ratio of 0.30 and a standard deviation of 12.60% during the period. Non dividend payers, on the other hand returned 3.52% annually and had a Sharpe ratio of 0.05 and a standard deviation of 15.79%.

In addition to better risk-adjusted returns, dividend paying stocks had lower systematic risk and were less sensitive to market changes.

Dividend-payers have stronger balance sheets

Over the 16-year period, dividend payers had a higher average return on equity; higher gross profit margins; lower debt-to-equity; and lower debt-to-asset ratios than non-payers. On average, they were also more profitable than non dividend payers and the underlying BMI universe (the Broad Market Index), as indicated by their higher ROE and higher gross profit margin. Given their lower debt-to-equity and debt-to-asset ratios, EM dividend payers have lower leverage in their capital structure than non dividend payers, and are therefore more likely to be able to meet their financial obligations.

Dividend payers diversified across different sectors

EM dividend payers are diversified across different sectors. In addition to defensive sectors such as utilities and consumer staples, cyclical and growth-oriented sectors such as energy, materials, and industrials also pay dividends. While the traditional dividend paying sectors, such as utilities and consumer staples continued to maintain their high historical average weights, contributions from non-traditional income sectors such as information technology have increased in recent years.

Dividend Payers by Region

The dividend contribution from the Latin American region represented 19% of EMs at the end of 2014, falling from 35% at year-end 1998. In contrast, dividend contributions from both the Asia-Pacific and Europe, Middle East, and Africa (EMEA) regions increased and represented roughly 35% and 46%, respectively, of overall emerging market countries’ dividend contributions at the end of 2014

In spite of the changing regional landscape, the study found that dividend payers across various regions have consistently had higher average annual returns than non dividend payers. After adjusting for risk, dividend payers in each region have had higher Sharpe ratios than non-payers and the overall market.

Dividend payers offer opportunity for diversification

Dividend payers not only tend to earn higher relative returns than non-payers, but dividend income also comes in a diverse array of sectors and countries, providing investors with an opportunity to diversify.

Dividend payers offer opportunity for enhanced yield

Traditionally, investors have turned to emerging markets for growth opportunities rather than yield. However, as EMs mature, two important developments have evolved —a rising percentage of companies paying dividends as well as higher payout ratios than developed markets—making enhanced yield strategies possible for income-seeking global investors.

The growing importance of investing in emerging markets

According to Bhim D. Asdhir, President & CEO of Excel Funds Management which invests solely in emerging markets, “the market capitalization of emerging markets has expanded exponentially since 2000 and is expected to surpass developed markets over the next two decades.” He adds: “In 2000, the total market capitalization of emerging markets was a mere USD $2 trillion dollars, compared to developed markets which accounted for USD $29 trillion. By 2010, the market capitalization of emerging markets had grown more than 8 times, to USD $17 trillion and by 2030, the capitalization of emerging markets is forecast to reach USD $124 trillion, almost 3 times the markets cap of the developed markets in 2014. It is further projected that by 2030, emerging markets, including those of the developed Asian countries, are expected to account for almost 45% of total global market capitalization, making the traditional developed markets less important when it comes to investing globally.”

Reflecting on the growing importance of EMs, the S&P Dow Jones study noted that the weight of emerging countries in global equity benchmarks has shifted tremendously over the past 20 years – from 0.6% in 1993 to 9.7% by the end of 2014 in the S&P Global BMI.

The study concluded that in addition to playing an important role in generating total return in emerging markets, dividends can potentially limit draw downs by providing downside protection during volatile periods. Together with higher yield, the risk/return properties of emerging market dividend payers may be worthy of consideration by investors who are seeking to access the economic growth potential of emerging markets.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.