Many investors are fans of dividends because of the income stream they provide. Whether you choose to live off of those dividend payments or reinvest them to help grow your wealth and investing capital, monthly, quarterly or annual dividend payments are an added bonus for investors, but there are other reasons to be bullish when it comes to dividends. For example, the ability of a management team to consistently pay a quarterly dividend points to favorable cash flow generation. Even better is what I discussed with you last week — dividend dynamo companies that have such strong business models that they can consistently raise their annual dividend. A great example of that is McCormick & Co. (MKC), which just raised its annual dividend for the 28th time.
There is another positive to dividends and dividend dynamo companies in particular. Before I get to that, I think you’ll agree that one of the hardest things in investing is how to assess what a stock you are eyeing is really worth. There are all sorts of valuation techniques and methodologies you can employ to determine that security’s value. Believe me, after working with institutional investors for a number of years I’m quite familiar with them: the price to earnings (P/E) ratio, the P/E to growth ratio, price to sales and enterprise value to earnings before interest, tax, depreciation and amortization (EBITDA). If what you are analyzing has a net cash balance sheet, you have to account for that in your calculations.
Another valuation tool you can use is dividends. More specifically, you can examine the company’s dividend yield against the highs and lows in its stock price. For those companies that I recommend to subscribers of PowerTrend Profits and for positions I am evaluating for the Thematic Growth Portfolio that I oversee for Fabian Wealth Strategies, this is a mandatory exercise. By identifying prior peaks and troughs in a stock’s share price going back several years and the corresponding dividend yield, we can build an historical framework of peak and trough dividend yields for the shares.
Applying those peaks and troughs to the current annual dividend establishes an upside price target for the shares, as well as a potential downside target. If we’re looking over a dividend dynamo company, the dividend yield’s upside to downside band steps higher as a company raises its dividend. In the case of a dividend dynamo company that raises its dividend each year, all things being equal, there is a step function higher in that upside to downside band.
Of course, when you’re analyzing a company and deciding to buy the shares, you want to make sure you have more upside in the shares than downside. My PowerTrend Profits subscribers know I prefer companies that offer net upside potential of at least 25%. That means at least 25% upside remaining after I subtract the potential downside from the potential upside. When looking to determine which companies offer such favorable upside characteristics, dividends and using dividend-yield analysis is a valuation tool that you should include in your stock analysis arsenal.
What’s Next for the Stock Market, Other than More Volatility, with Cuttone’s Keith Bliss
Joining me on PowerTalk this week to discuss the recent pullback in the stock market and where it is likely to head, both in the near term and longer term, is my good friend Keith Bliss. Keith is a senior vice president at Cuttone & Company, the floor broker with the largest operation at the New York Stock Exchange. I’ve known Keith for many years now, and this is the kind of conversation that he and I have on a more-than-periodic basis. It is an inside baseball conversation about the stock market, and I think you’ll find it very timely.
As Keith points out, investors will be dealing with volatility in the stock market as the Federal Reserve continues to taper its monetary-stimulus, quantitative easing efforts. Alongside that, economic data, corporate commentary and other tea leaves will determine the direction of the stock market. After talking with Keith, I think you will be more than surprised by what he has to say.
That said, we both agree there are pockets of opportunity to be had — pain points such as cybersecurity and the current drought situation, as well as opportunities, such as the intersection of mobile, the Internet and computing, that are reshaping industries and business models around us. Keith and I also discuss a looming pain point in the United States — the increasingly older U.S. population that is looking like it will not have enough retirement savings to last its golden years. Data from a number of sources reveals 44% of Americans are living paycheck to paycheck, the average 401(K) balance is only $64,000 and the payroll-to-population ratio in January was just 42%.
Make no mistake, there will be some long-term pain felt. The question you should be asking yourself is: how do YOU profit from it?
In case you missed it, I encourage you to read my PowerTrend Brief from last week about weathering the stock market storm with dividend dynamos. I also invite you to comment in the space provided below.