In this article we will explain the calculation of Pay Out ratio of Russell 2000 which is one of the most important factor for determining the overvaluation already mentioned in this blog (see Russell 2000’s overvaluation could be more than 60%)
This publication could be also interesting as an example of the calculation of a normalized Pay Out ratio of an index considering its relation with ROE ratio of the index and the growth factor, g.
Russell 2000 seem clearly overvalued even considering a very bullish Pay Out ratio of 72%
The Pay Out is calculated as the historical Pay Out average since 1995, excluding 2001, and the period between 2007- 2009 which are years with dates above 100% that we consider unsustainable in the long term.
Nevertheless, dividends are not the only source of remuneration for the shareholders. Share buyback programmes should also be considered, but unfortunately we do not have this aggregated information for the Russell 2000 index. To mitigate the lack of this information, it is worth comparing the Pay Out ratio for Russell 2000 and the same ratio for S&P 500. In the latter case, the Pay Out ratio is calculated according to the following equation:
Proceeding in this direction, we avoid forgetting other remuneration to the shareholders apart from dividends.
|Russell 2000 Pay Out average from 2000 (excluding 2001, 2007-2009)||72.33
|S&P 500 Pay Out||74.38||32.28|
Despite the aforementioned lack of information, 72.33% is high enough to leave little room for erroneous estimation, considering that this Pay Out ratio implied a long term growth of 3.6% and ROE of 14.05%, which is significantly above the historical data. In addition, the Pay Out is calculated by dividing the aggregated dividends by aggregated EPS, and only companies with positive EPS would contribute to the numerator, but the denominator is the EPS of companies with profits subtracted from the EPS of companies with losses which are 30% of the index. In this sense, the Pay Out is expected to be higher than the average of the Pay Out of the index members.