I usually try to analyze one dividend paying company every week. In a typical stock analysis report, I would outline the years of consecutive dividend increases along with the amount and timing of the latest dividend increase.
I would then look at trends in stock prices, earnings per share, dividends, dividend payout ratios and returns on equity over the preceding decade. Right under earnings per share, I typically try to discuss qualitative factors that might drive future profitability. Basically in the article I discuss how I like a record of dividend growth, earnings growth and a sustainable dividend payout ratio. If the stock has these traits, I then focus on valuation.
In my conclusion section, I usually link to my article on entry criteria when I call a stock attractively, fully or overvalued. In my article on entry criteria I discuss that I am not willing to pay more than 20 times earnings for a stock and require at least a 2.50% in minimum yield. If the company trades at less than 20 times earnings, and yields more than 2.50%, I would call it attractively valued and call it a day.
However, if the stock trades above 20 times earnings or yields below 2.50%, I would try to calculate a reasonable price which would make it a good buy on dips. This entry criteria applies to most corporations that pay dividends and are traded on exchanges.
For example, Automated Data Processing (ADP) trades at 25.80 times earnings, which is above the price I am willing to pay for it. If it earns $2.89 per share, at 20 times earnings, the most I would pay is $58 per share. Hence, if I posted an analysis on ADP I would say it is overvalued at 25 times earnings, and would buy on dips below $59.
If Automated Data Processing traded at $50 per share, and earned $3 per share, I would say it is attractively valued at the moment. For example, in my analysis of Wal-Mart (WMT), I discussed that I thought the stock was attractively valued at the moment. Hence, I recently bought some for my 2013 Roth IRA.
I link to my entry criteria article, because I want readers to understand how I value company stock. For Automated Data Processing I assigned an entry price of $59 at $2.90 per share in earnings per share. If you read the article in 12 months and the stock trades at $70 but earns $4 per share, you would think it is above fair value and ignore it completely for that reason.
However, at $70, the stock would have been attractively valued
Readers would notice that I do not assign “fair values” to stocks I analyze. I am not going to complicate my screens by using discount rates, forecasting future dividend payments and discounting them back etc.
Instead I use the P/E and yield as mentioned above. However, I do select companies that have raised dividends for at least a decade, and which usually have done so above the rate of inflation. In the end, yield and dividend growth is a balancing act.
I select companies that have not only raised dividends by say over 5% to 6%, but I believe also have a decent shot of continuing that in the foreseeable future. I expect dividends to grow over time, I just don’t want to overcomplicate things by assigning forecasted values and proving my point mathematically. I would avoid doing math since I can mention my expectations with one single sentence or less, and have them already built into the assumption.
Check my four latest analyses of dividend paying stocks below:
- Coca-Cola (KO): A Core Holding for Dividend Growth Investors
- McDonald’s Corporation (MCD) Dividend Stock Analysis
- Air Products and Chemicals (APD) Dividend Stock Analysis
- Exxon Mobil (XOM) – An Undervalued Dividend Machine
Full Dislosure: Long ADP, WMT, KO, MCD, APD, XOM