Author Dave Van Knapp
EXCERPT FROM CHAPTER D-4: DIVIDENDS AS A VALUATION
TOOL
[R]emember that the goal of valuation is to determine whether a stock is selling at
a bargain. Because companies that pay dividends rarely lower them, a stock that
pays a dividend already is “guaranteeing” a certain return on your investment.
Common sense therefore suggests that a stock’s dividend yield ought to be
considered as a potential “plus factor” in valuing the stock. Sometimes one hears
the phrase that a decent dividend yield “places a floor” under the price of a
stock. While this is an overstatement (sometimes companies do cut or even
eliminate their dividends), it conveys the general idea: If all the valuation ratios
are equal, a dividend-paying company is a better buy than a non-dividend-paying
one.
Note that in adopting this point of view, we are rejecting a notion sometimes
heard that an investor should not care whether a stock pays a dividend, because
he or she should be indifferent as to whether a company pays a dividend to its
shareholders or the company keeps that money—to reinvest in itself to fund
expansions, to buy back its own stock, to buy other companies, or whatever.
We do not think that the Sensible Stock Investor should be indifferent on this
issue. As was explained in Part C, too much cash on a company’s hands is often
not a good thing, because the company’s executives frequently lose discipline
about what to do with it. Paying a regular dividend is a good discipline for a
company—it helps keeps the interests of the shareholders in the foreground (as
opposed to, say, funding low-potential projects or wasting money on empire-
building). Dividends also are a sign that the company has real cash behind its
earnings to pay the dividend and that its earnings are not the result of accounting
legerdemain. That is the kind of company a Sensible Stock Investor wants to own.
...So the Sensible Stock Investor considers good old cash dividends to be a plus
factor—not the only standard for measuring a company’s worth, certainly, but
one with a role to play in the appraisal.
What level of dividend yield is enough to make a difference in assessments of
valuation? It would not be unreasonable to suggest that a company paying more
than the S&P 500’s average yield (about 1.7 percent) is providing a decent head
start on total return and that a 2 to 4 percent yield is a significant head start.
As usual, we will utilize a point-scoring system for evaluating dividend yields in
our Easy-Rate system. The complete point scale for dividends will be shown in
the next chapter, along with the point system for all the valuation ratios that we
use.
TOOL
[R]emember that the goal of valuation is to determine whether a stock is selling at
a bargain. Because companies that pay dividends rarely lower them, a stock that
pays a dividend already is “guaranteeing” a certain return on your investment.
Common sense therefore suggests that a stock’s dividend yield ought to be
considered as a potential “plus factor” in valuing the stock. Sometimes one hears
the phrase that a decent dividend yield “places a floor” under the price of a
stock. While this is an overstatement (sometimes companies do cut or even
eliminate their dividends), it conveys the general idea: If all the valuation ratios
are equal, a dividend-paying company is a better buy than a non-dividend-paying
one.
Note that in adopting this point of view, we are rejecting a notion sometimes
heard that an investor should not care whether a stock pays a dividend, because
he or she should be indifferent as to whether a company pays a dividend to its
shareholders or the company keeps that money—to reinvest in itself to fund
expansions, to buy back its own stock, to buy other companies, or whatever.
We do not think that the Sensible Stock Investor should be indifferent on this
issue. As was explained in Part C, too much cash on a company’s hands is often
not a good thing, because the company’s executives frequently lose discipline
about what to do with it. Paying a regular dividend is a good discipline for a
company—it helps keeps the interests of the shareholders in the foreground (as
opposed to, say, funding low-potential projects or wasting money on empire-
building). Dividends also are a sign that the company has real cash behind its
earnings to pay the dividend and that its earnings are not the result of accounting
legerdemain. That is the kind of company a Sensible Stock Investor wants to own.
...So the Sensible Stock Investor considers good old cash dividends to be a plus
factor—not the only standard for measuring a company’s worth, certainly, but
one with a role to play in the appraisal.
What level of dividend yield is enough to make a difference in assessments of
valuation? It would not be unreasonable to suggest that a company paying more
than the S&P 500’s average yield (about 1.7 percent) is providing a decent head
start on total return and that a 2 to 4 percent yield is a significant head start.
As usual, we will utilize a point-scoring system for evaluating dividend yields in
our Easy-Rate system. The complete point scale for dividends will be shown in
the next chapter, along with the point system for all the valuation ratios that we
use.
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