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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