Tag: stocks

Dividend Investing and Earnings Yield on Stocks

Stock Seminar

Dividend investing is for people seeking income from their investments, who are also willing to take on a little more market risk than bonds offer in order to try to achieve growth in both their principal and the dividend income provided by their dividend stocks, not just by chasing the highest dividend stocks. A successful dividend investor knows that this strategy can help them stay ahead of inflation.

One of the first steps in dividend investing is identifying companies that are in a position to not only maintain the dividend that they are paying out to their dividend investor base, but can also as a dividend growth stock opportunity. A good way to determine if a stock fits this criteria is to look at it’s dividend payout ratio.
Dividend Payout Ratio

The dividend payout ratio can be calculated in a number of ways, so we’ll look at two of them and let you decide which one to use for your dividend investing screens (my favorite dividend payout ratio calculation is the second one).

The most popular way is calculated by dividing the annual dividend a company pays out per share by it’s annual earnings per share.

Dividend Payout Ratio = Annual Dividend Per Share / Annual Earnings Per Share

These numbers are readily available at most popular financial web sites, and can be included in dividend investing screens at sites like MSN Money. Using this version of dividend payout ratio calculation, a level of 50% or lower is considered good. So, this calculation is pretty easy, and the data is readily available, but for good dividend investing principals, it has a flaw…

The problem with the above calculation is that EPS has some noise embedded in it that can mis-lead a dividend investor into buying a company that is not a dividend growth stock candidate. In my view, good dividend investing stocks’ dividends need to be paid out of the ongoing cash operating profits a company generates, and due to GAAP accounting rules, EPS contains more than this. For dividend investing, it is better to use annual free cash flow (FCF) instead of EPS in the dividend payout ratio calculation.

Since free cash flow takes into account both expenses and capital outlays, it shows how much cash is left over from company operations to apply to dividend payouts. With the inherent noise in EPS taken out of the dividend payout ratio calculation, a level of 60% – 65% or lower can be considered good for dividend investing (obviously lower is better in either method of calculating dividend payout ratio).

Earnings Yield

Earnings yield can help value stocks investors in their quest to find good solid companies that are currently relatively cheap. Using indicators like return on invested capital (learn how to calculate ROIC), can be helpful in finding a list solid companies, and once you’ve identified this list, earnings yield can help you determine if the company is cheap enough to buy right now, after all, that is what value stock investing is all about. Earnings yield does this by dividing a company’s annual earnings per share (you can use a trailing 4 quarters view of EPS for this if you’d like) by the company’s current market price per share. This number is expressed as a percentage, which makes it easy to compare with bond yields.
How to Calculate Earnings Yield

There are a couple of ways to calculate earnings yield. Since you don’t find this number in a lot of free online stock screeners, I’ll cover both methods, and you can decide which one you want to use.

The first way to calculate earnings yield is to take the inverse (1/x) of the P/E ratio. Since P/E ratios can be found in most financial publications, web sites, and stock screening tools, it is very easy to find this number, and invert it on a calculator or in a spreadsheet, to give you the earnings yield. This method is very simple to use, and gives you a quick view of how cheap (or expensive) a stock is.

The other way to calculate earnings yield is a little more involved, but gives you a better understanding of how a company is valued relative to it’s earnings. This form of earnings yield was written about by Joel Greenblatt in his book, “The Little Book That Beats the Market”. The earnings yield he created is useful in comparing companies with different tax rates and levels of debt. Greenblatt’s earnings yield formula is:

Earnings yield = pre-tax operating profit (EBIT) / Enterprise Value

So, in this case, the numerator (EBIT) comes from the income statement, and the denominator (Enterprise Value) is calculated by adding the market value of all equity – both common and preferred – to the value of all interest bearing debt that the company owes. The value of equity is just the shares outstanding multiplied by the price of the stock, and interest bearing debt can be found on the company’s balance sheet.

I like Greenblatt’s method of calculating earnings yield better than the more popular E/P method, since it gives a more accurate view of what is happening inside of a company, and also gives a more balanced view when comparing multiple companies to each other.

Stocks That Pay Monthly Dividends

Stock Seminar

While you have probably heard about stocks that pay dividends every quarter, did you know that there are many stocks that pay monthly dividends? When many income investors think about investing for dividends, they naturally look at safe, stable companies like McDonald’s(MCD), Proctor & Gamble(PG), and IBM (IBM), which have a long history of paying quarterly dividends. These types of dividend stocks are usually financially stable, have a lot of liquidity so they are easy to buy and sell, and have enough income and cash reserves to cover their dividend payouts to investors every three months.

There are a couple of issues that investors in these type of quarterly dividend stocks should consider. First, the investors income stream is exposed to a single company for each stock that they own, and second, depending on the mix of stocks in the investors portfolio, the dividend income can be very lumpy (i.e. most of the dividend money arrives in one month of the quarter, leaving the remaining two months with very little cash coming in.

Stocks that pay monthly dividends are an alternative that can provide regular, consistent, income to investors, and overcome the two main issues highlighted above.

First, monthly dividend stocks are typically traded on regular stock exchanges, and have enough liquidity for investors to easily buy and sell them. Stocks that pay monthly dividends are usually trusts, closed end mutual funds, and other investment vehicles that actually own a portfolio of income producing assets. This benefits investors because they get the diversification of the underlying portfolio owned by these companies, so investors are not as exposed to single company risk as they would be if they owned a single company that paid a quarterly dividend.

Second, since the income stream from stocks that pay monthly dividends comes three times as often as the cash flow from their quarterly brethren, the income is not going to be as lumpy. This is a significant benefit for investors that need regular income, like retirees that need a passive source of retirement income to meet their monthly needs.

One of the obvious items that investors considering purchasing stocks that pay monthly dividends over a company that pays a quarterly dividend is understanding the assets that are held by the monthly dividend company. While this adds an extra research item, it is very easy to find this information in the standard government filings that publicly traded companies have to file with the SEC.

Mutual Funds, Annuities and Structured Settlements: Understanding the Differences

Stock Seminar

In the financial world, it is important to be able to know the differences between various types of financial terms. Mutual funds, annuities and structured settlements are among some of the most confused, so here are the differences between the three.

Mutual Funds

This a way for which you are able to branch out for a minute amount of cash that could not have been otherwise possible. Small investors are the ones that typically invest in these funds. Whenever you purchase mutual funds, what you actually do is get stake rights in an investment organization. There are fund managers in these firms that invests the funds on your behalf. Besides investing, they purchase and sell also whenever they deem it to be profitable.

There are other investors also that have stake rights in the exact same firm. The reason as to why such investments are viable is because cash from a huge group of individuals is accumulated and then invested. Normally, the cash investors with all that accumulated funds invest the cash by buying different stocks and bonds. It suits a lot of investors since a mutual fund is a very simple investment that offers a sizable diversity. What is great regarding mutual funds is the fact that you just need to keep an eye on a solitary investment; instead of various multiple investments. You will get quarterly or annually net profits, or might even need to payout net losses during an awful year.

Annuities

This is basically an agreement normally between a client and an insurance firm. It makes for an exceptional way to obtain payouts for a set period of time or an entire lifetime of a person. An annuity can be purchased by either paying in small installments or in one lump amount. The profit advantage of annuities can be maximized immediately or perhaps deferred up until you reach retirement and is an excellent way of receiving profits in long term. A lot of individuals do not know how to properly manage investments as well as taxes and hence they resort to employing insurance firms.

The insurance firms have trained employees with the apt skills needed when it comes to knowing how and when to make a smart investment. After a preset time, the sum you used in buying the annuity will be reimbursed by your insurance firm with the aid of standard payments. The payments can be on a monthly basis, quarterly basis or yearly basis, and what is good is that, you will continue to receive the payments for the rest of your life. The insurance firm collects annuities from various individuals in order to spend in gainful ventures. The payouts to the customers are paid through the amount that is made out of the profit.

Structured Settlements

This is sort of like an insurance or financial agreement that entails regular payments referred to as intermittent payments that a person accepts out of some type of injury claim or other payout compulsion. A structured settlement is an excellent option to lump sum payment. A lot of victims of accidental injury prefer getting these settlements as opposed to a lump sum amount since it makes for a suitable way of getting compensation for an extended duration of time or possibly even for an entire lifetime.