Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
Investment Portfolios Through Valuation Ratios: A Simple
Methodology to Obtain Returns in The Capital Markets in Chile
Alejandro Torres Mussatto and Eric Salinas Mayne
The proposed research shows the informational power that the dividend policies of firms
have in the Chilean stock market. For this purpose, the stocks of firms belonging to the
main index, the Selective Stock Price Index (IPSA) of the Santiago Stock Exchange, were
put into groups considering the percentages of profit sharing of their shareholders.
By using the valuation ratios, it is possible to determine the intrinsic values of the shares
comprising the index. This leads to the suggestion of purchasing undervalued securities
that were undervalued by the market from stocks that reached the highest dividend
distribution rates. In addition, they showed that greater dividend rates were preceded by
growth rates of large firms.
Complementing the results above, the firms that share higher profits to shareholders are
those who have property in greater concentration, along with reaching greater yield results
than those obtained by firms that spend a smaller percentage of their dividend distribution.
Key words: Valuation; Return; Investment.
Introduction
The news related to the end of economic stimulus stated by the Federal Reserve of the
United States have strongly impacted the yields of securities in emerging markets. Such
scenario has caused an obvious outflow of investment to developed capital markets,
reflected by the historical standards achieved by the Dow Jones Industrial Average or the
Standard & Poor's 500.
In Chile, the Santiago Stock Exchange, through its main indicator IPSA (it holds 40 firms
of higher stock market capitalization), fell 11% only during the first half of 2013.
Therefore, if yields are generally low or directly negative for most of the securities, it is
necessary to propose a methodology that allows profitable investment portfolios and the
interpretation of the information given by the profit-sharing policies from different firms.
_____________________________________________________________________
Alejandro Torres Mussatto, Professor Department of Economics and Business Administration, University of
Valparaíso, Controller, Senate, Chile, +5632 2504450 (Of.), atorres@senado.cl
Eric Salinas Mayne, Academic Director, MBA and Master Program, Professor Department of Economics
and Business Administration, University of Valparaíso, +5632 2507543(Of.) eric.salinas@uv.cl
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
Objectives
General Objective:
To identify and interpret the policies of dividends of firms in the Chilean
capital market; belonging to the Selective Stock Price Index (IPSA).
Specific Objectives:
- To determine the profit of a defensive portfolio
- To conclude whether or not the percentage of control of the property of
the firms analyzed influence dividend policies.
- To interpret dividend policies through valuation indices or financial
reasoning.
- To demonstrate the relation between growth rates and dividend payments.
Theoretical Framework
At a time when the security yields have given negative results, one of the possibilities portfolio
managers have is to focus their analyses on stocks that distribute a larger amount of dividends. In
Chile, the current legislation requires publicly- traded corporations (the largest ones) to distribute
at least 30% of realized profits from their late previous year.
If we recall some of the basic tenets in valuing stocks, we can say in its primitive form that their
profits are given by capital realized gains (sale price higher than the purchase price), plus dividend
yields during the period in which the shares belonged to its owner.
Now, if you cannot "buy low and sell high a stock" as a basic principle of investment because the
economic conditions are not favorable, another way to make profit is through dividend payments.
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
For this reason, we must focus our portfolio in stocks that distribute a higher amount of dividends,
the so-called "defensive stocks".
For the purposes of valuing shares by using indices or financial reasons, and selecting the
securities that could be part of an investment group, the following criteria have been considered:
1. Pay out:
It represents the percentage distributed as a dividend in relation
to the profits obtained in the period.
2. Reinvestment Rate:
If the previous index shows, in relative terms, the
amount of profit distribution, the reinvestment rate would
indicate the profit rate available in the firm for its reinvestment.
3. Historical Growth Rate:
If we ask ourselves what elements of financial statements we
should focus our analysis on in order to determine a firm´s
growth, it is understood that it should reflect at least a growth
in its assets, liabilities, equity, incomes and sales.
The ratio, Return on Equity (ROE) index, groups these
variables. Through reinvestment adjustments, it reveals
publicly available information that could infer a firm’s growth
by using audited and published financial statements.
4. Price Earning Ratio (PER):
It represents all those investors who are willing to pay for
earnings. A high PER suggests: investors are willing to pay
more; greater sacrifice from consumer surplus; good market
perception; low risk level for the firm; and a high pay back;
therefore, gives more time to recover the investment and a low
beta.
5. Book-to-Market Ratio:
It compares the book value (i.e. accounting value) of a stock to
its market value in the stock exchange.
6. Intrinsic Value:
It relates the PER, from the point of view of the perception of
the market, with projected profits as a potential generator of
flows.
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
This intrinsic value is compared with the current stock value,
determining if securities are at an underlying stock’s price (to
buy) or strike price (to sell).
Methodology
In a-three- year period with figures that closed on June 30th, 2013, 5 types of portfolios or
investment portfolios were constructed according to the percentage of the profits to pay dividends.
Group 1 includes firms whose dividend rate is between 70% and 100%; group 2, firms whose
dividends are between 51% and 69%; group 3 for those who distribute 50%; group 4 for firms that
distribute between 31% and 49%; and group 5, those who distribute the statutory minimum of
30%.
Results
1. Profitability of portfolios, according to dividend distribution
In the investigation period, the only portfolio that obtained positive returns was group 1, i.e.
one that is constructed of stocks whose firm distributes as much of their earnings as
dividends. The returns obtained reach 12.14% for group 1, in circumstances where the
Chilean benchmark fell 11%.
A summary of the results is shown in the following table:
Group
1
2
3
4
5
Return last 12 months
12.14%
-1.77%
-19.57%
-4.59%
-17.66%
Firms that only distribute the legal minimum obtained a negative return of -17.66%.
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
2. Relation between the percentage of ownership and the dividend distribution:
Considering both regulatory agency figures of firms issuing public stock offering and
control rate of the 12 largest shareholders, the results were:
Group
1
2
3
4
5
Control 12 largest shareholders
88.30%
84.81%
80.30%
80.11%
74.14%
Therefore, the firms that pay higher dividends have a more concentrated ownership
structure compared to those who share a lower proportion of their profits.
3. Cash flow and profit-sharing:
Group
1
EBITDA/N°STOCKS
CLP$ 541 (1.1 US$)
2
CLP$ 775 (1.6 US$)
3
CLP$ 686 (1.4 US$)
4
CLP$ 103 (0.20 US$)
5
CLP$ 123 (0.25 US$)
As stated by one of the latest theories related to dividend policies, the so-called life cycle of
dividends suggests that firms tend to pay dividends when they are established, mature and have
high cash flows.
In this study, we came to the result of firms with a higher level of EBITDA adjusted accordingly to
the firm size, shared a greater amount of dividends.
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
4. Relation between growth rates and dividend payments:
Group
1
2
3
4
5
Growth
0.05
0.04
0.03
0.03
0.02
Higher growth rates, depending on the proposed valuation ratios, are associated with higher
dividend payments. The firms that distribute a larger amount of dividends grow at an average rate
of 5%, related directly with the GDP growth of the Chilean economy in the same period.
5. Valuation ratios and dividend policies:
After calculating the valuation ratios necessary to determine the intrinsic value of the share,
the results are:
Group
1
2
3
4
5
Purchase Recommendation
100%
66%
77%
71%
75%
Sales Recommnedation
0%
34%
23%
29%
25%
In the case of firms that distributed all of their earnings as dividends, and determined their
intrinsic value as a function of generator power of profits and market perception, 100% of
the cases presented higher intrinsic values than the stock prices; therefore, it is
recommended to purchase all the stocks of the group.
Proceedings of 3rd European Business Research Conference
4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
6. Dividend policies and economic sector:
Economic Sector
Industry
Bank
Retail
Commodities
Construction
Utilities
Dividend (%)
53.1
53.4
35.8
42.5
30
58.6
From the point of view of organizing the economic sector in accordance to the firms they
represent, the ones that pay the most dividends are those whose activity is oriented to basic
services (electricity and water), with 58 , 6% on average, mainly because they are services
regulated by the Chilean law, which makes their cash flows constant and considerable in time.
However, firms classified in the construction and real estate business have the lowest rates of
dividends, according to the high levels of investment required, and lower profit-sharing results.
Conclusions
Through the calculations of the indicators, we came to the conclusion that dividend payments have
a high informational content. A generous dividend policy implies portfolios that deliver higher
returns in periods where yields are generally negative in all the Chilean stock market.
On the other hand, we can infer that higher dividends come from firms that have more
concentrated ownership structures, higher rates of growth (according to valuation indices), higher
cash flows and that are more mature. They also recommend to buy stocks that contain intrinsic
values undervalued by the market.
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4 - 5 September 2014, Sheraton Roma, Rome, Italy, ISBN: 978-1-922069-59-7
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