So you’re a numbers person and don’t want some random guy on the internet telling you what to invest in? Good for you. I was the same way....I was always wondering how to dive deeper into what was truly a good stock price. As I said in the previous article, for dividend growth investing you can get a pretty decent start with buying companies you know that meet the right criteria in their basic stats. When your portfolio is starting to grow and you want to acquire new companies, we will need a way of evaluating stocks at the next level. I'll go over 4 pieces of information that I use to determine good stock purchases. We always want to evaluate basics before looking into these stats, but these will give you an idea of how you can incorporate stock price into the equation.
Payout Ratio - (Dividends Per Share/Earnings Per Share) - To dive deeper, we need to look at how much money the company is paying out in dividends as a percentage of their earnings. The "normal" amount will depend on the industry, but this will give you an idea of how much room a dividend has to grow. If the payout ratio is around 50%, it’s likely they can increase or at the very least maintain the payout through several down business years. You can also evaluate payout ratios over time, for example the last 3-5 years. A spike in the ratio might serve as a warning sign, while maintaining the same low percentage will help us sleep comfortably at night. We want the payout ratio to remain at a healthy level year after year.
1,3,5 Year Dividend Growth - Growth of the dividend yield over the given time period. This helps us pick stocks that might not have the yield we want YET, but are rapidly reaching our cutoff point. The higher the number here, the better, given its not affecting any of their other stats negatively (mainly payout ratio).
The next two things help us evaluate companies at their current stock price. It also can help us compare a company against its competitors. After all, when purchasing a stock, we'd like to know that the company we buy is a better value than all its competitors in a given industry.
PEG Ratio - (PE Ratio / Earnings per share Growth) - helps us evaluate how much we are paying in price for a company's future value. It should be noted that EPS growth is an estimation, but it’s usually an accurate one as public companies are required to provide some calculated guidance. The lower the PEG ratio, the more value we are getting for our dollar invested.
PEGY Ratio - (PE Ratio / EPS Growth + Dividend Yield) - takes it one step further and adds in the dividend we'll receive when assessing the value of a stock. After all, when trying to assess the value we are getting, its useful to include the payouts we'll be receiving quarterly as well as the projected earnings growth.
Let's run through an example here. I'll pick one we all can relate to, but in this case both companies are actually a good buy, but which is a better value right now? Walmart vs Target.
P/E Ratio: 13.9
Dividend Yield: 2.92%
# of Consec. Years for Div Increase: 40 years
Dividend Growth 1 yr, 3 yr, 5 yr: 2.13%, 9.56%, 11.99%
Payout Ratio: 40.77%
EPS Growth: 5.04%
PEG Ratio:(13.9/5.04) = 2.76
PEGY Ratio:(13.9/(5.04+2.92) = 1.75
P/E Ratio: 17.46
Dividend Yield: 2.69%
# of Consec. Years for Div Increase: 47 years
Dividend Growth 1 yr, 3 yr, 5 yr: 20.25%, 19.98%, 23.55%
Payout Ratio: 45.93%
EPS Growth: 10.96%
PEG Ratio:(17.46/10.96) = 1.59
PEGY Ratio:(17.46/ (10.96+2.69) = 1.28
I'll start by saying both of these companies are great values in my opinion. Both have paid out increasing dividends 40+ years, and both have very low payout ratios under 50% of revenue, which indicates the dividend has plenty of room to remain steady and grow.
Interesting to note without calculating any of our more advanced stats, Walmart looks like the clear winner with a lower P/E ratio, lower payout ratio, higher dividend yield, and a very long history of payouts (although not quite as long as Target). Where these companies separate is with projected EPS growth. Target is expected to grow earnings 10% vs WalMart's 5%, which gives us more long term value. Another thing that fuels Targets value for us is the dividend growth numbers, which are somewhat in line with their high EPS growth numbers. Target is expected to have more EPS growth and therefore have been recently rewarding investors with a rapidly improving dividend payout. So while today it still trails Walmart's dividend yield, it doesn't seem like that will last over the next 5 years.
There are always minor blips in a long history of success, which Target had recently with the data breach and a somewhat unsuccessful start with its Canadian stores. This is the kind of activity that pushes stock price down, but hasn't really affected Target's bottom line and it is now a somewhat "cheap" stock to buy for the growth potential they have. Despite its 2014-2015 struggles with the data breach, we know that their payout ratio is under 50%, so they'll continue paying us quarterly with a wide margin of safety.
Hopefully this brings a little more math into the equation for all you numbers nerds. It never hurts to give every company a thorough valuation to make sure we feel confident about owning it. After all, when the stock is fueling your financial independence in future years, you don’t want to have to worry about anything but collecting your dividend checks!
So after doing this analysis and deciding both of these companies were a great investment opportunity....BOOM....Walmart drops 10% in price and Target drops about 5%. I've added both to my portfolio since the drop off. People are concerned about retail sales being down and maybe a little about worker wages. But these are retail giants. This is a perfect example of a company's stock price dropping caused by panic that doesn't really affect its bottom line much. I bought both right after the stock drop, and am very happy to be a stockholder.
I follow several financial bloggers on Twitter (@monthlycents) and it’s always interesting to note the difference between what the public says and what the dividend investor bloggers are doing. I've seen almost everyone open up or expand their position in WMT in the last few days, while the rest of the public gives up too easily on a company that has paid steady, increasing dividends for almost half a century!
Needless to say, these companies are now a greater value in my opinion.
Okay, for those non-numbers people who are drifting off, I’ll try to write something a little more entertaining for my next post. I get bored writing about numbers, although I love to look at them constantly!