Today, permit me to share a very recent interaction I had with a reader of my book, “Choose Stocks Wisely.” I’ve had several good e-mail conversations with this friend over recent years and he posed an interesting observation in our latest interaction. He wrote the following:
“I’ve been reading about the dividend yield being one of the better valuation measures, and then looking at the yield over time. https://www.longtermtrends.net/dividend-yield/
It appears that about 6.2% is a yield that is considered to be the beginning of value territory by the folks who created the above chart. Assuming the current S&P dividend of $52.34 remained constant that implies an S&P price of $840. But during the financial crisis the dividend only rose to 3.6% which implies an S&P of $1455.
I think buybacks affect this long time value metric, but I’m not sure how. So I’m writing to ask your opinion on what level or range of dividend yield you think would indicate the beginning level of value in today’s environment.”
The following was my response to this friend:
“This is not a cheap market as you know. And that dividend yield chart link you submitted sure emphasizes that, doesn’t it? In fact, it almost reveals a structural change in the market’s valuation based on dividend yields starting from the early 1990s till the present except for that brief visit to normalcy during the great recession of 2008 and 2009.
So, the question is what do we do with the last 25 years relative to the 100+ years that preceded that. I really don’t know whether we exclude the last 25 years, average it in with the full history, or exclude the 100+ years ending in the early 1990s. In my view, it’s anyone’s best guess. However, I’m very conservative; I’d probably use something in the neighborhood of 5% as a starting point, thus giving some credence to what seems to be a new norm without throwing deeper history to the curb.”
Also, I shared the following quote (sourced in link below the quote) from an article:
“Screening for stocks with dividend yields above their five-year average can help you find potentially undervalued stocks with downside protection (the dividend payment), provided the dividend is secure and expected to grow, and the firm is financially sound. Some metrics that can be used to determine if a dividend is sustainable is the earnings payout ratio, the free cash flow payout ratio and the ratio of cash per share to dividend per share.”
Source:
https://www.aaii.com/journal/article/a-dividend-approach-to-judging-the-value-of-stocks.touch
I finished my response with the following:
“Of course, the above quoted comment of screening via the last 5 year average would imply (on a macro level) acceptance of a relatively new norm — that being greater than a ~2% dividend yield representing value. We probably both concur this is not a conservative perspective — that is, one we are confident will hold indefinitely where the era preceding the 2000s won’t be revisited again.”
Thanks to this reader for raising a very interesting issue about “value” in this present stock market in light of historical dividend yield norms. Of course, the dividend yield (for dividend paying stocks) is the annual dividend amount paid on a share of stock divided by the current stock price per share. Please jump in and offer your thoughts. And have a great weekend, friends.
Thanks very much for this interesting article. Lots of us focus on dividend-paying stocks and selection of companies with good fundamentals is vitally important. I have used the Stock Investor Pro database for about as long as it has been available. Please let me offer a word of caution: SIP cannot always be relied upon for accurate accounting data. Take a look at their data for short term and long term debt, and compare it with other data sources such as Morningstar. Once you open a credibility gap you can never close it.
This AAII article mentions an excellent means of judging the reliability of a dividend payment: “By analyzing the pre-dividend free cash flow payout ratio, you can determine how much free cash flow is available to pay the dividend.” However, SIP does NOT calculate that metric. Instead, it subtracts the dividend from Free Cash Flow. I have pasted the SIP definition and formula for this metric below.:
“Free cash flow per share for the latest 12-month period and for each of the seven most recent fiscal years. Computed from the statement of cash flow as cash from operations minus capital expenditures minus dividends paid.” “Free cash flow per share = (Cash from operations – Capital expenditures – Dividends paid) / Average Shares Outstanding” I have never seen any reputable analyst deduct dividends when calculating free cash flow. Have you?
I regret to say that I have tried over and over to get the nice folks at AAII to improve the quality of the accounting data but have not gotten any response. Maybe if enough users demanded better quality something might be done.
There is an outstanding add-in program called XLQ that directly reads the SIP database. I use it every day to take a first look at companies and I highly recommend it. It is easy to set up models to do most anything using xlq.
When I need to know that I am using accounting data that is accurate, timely and complete I rely upon Intrinio’s US Fundamentals and Stock Prices. Monthly subscription costs $40.
David, thank you for the helpful commentary. In my PhD work, I read articles making the case that the best definition for “asset” is “cash.” It certainly is the most objective, measurable and verifiable form. Determining free cash generation is surely something investors need to consider carefully. Accounting data is obviously required for rational decision-making and the accounting data indeed can only be trusted to the degree it has been prepared accurately and truthfully and monitored by the auditing profession sufficiently to provide a substantive (audited) opinion as to fairness. Resorting to sec.gov, the primary source of company accounting data (company filings), is a good place to go investigate accounting data thoroughly. Thanks!!