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 FINDING BARGAINS AMONG DIVIDEND STOCKS
 

   This is a translation of the former paper published by André Gosselin on the OrientationFinance.com web site on November 08 2005 ( Read the original paper in French here).

 

   * Extract written by André Gosselin published in his book "Investir dans les titres de grandes entreprises".

   Geraldine Weiss does not hesitate to use in her investment strategy some basic technical analysis, or more exactly charts, in order to have a good overview of a stock behavior in the market. According to her, a 25 years horizon is the ideal, but a 12 years stock exchange history is sufficient to have a good idea of the market value of a share.

   When we take a close look to the recommendations Mrs. Weiss proposes to her financial letter subscribers, we notice that, when the dividend does not represent more than 1 to 3 percents of the stock price, that is a clue that the stock price is currently too high. When the dividend reaches a percentage which goes beyond 5 percent of the stock price, the stock valuation starts to appear like a bargain.

   But, once again, it is all relative. A stock A is a true bargain when its price reaches a historically low support in a 12 year range, so that the dividend accounts alone for a return of 12%. With regard to the company B, the bargain is found when the stock price, in a 12 year horizon, has reached a support that makes it possible to believe that, with a 6% dividend yield, the investor makes a very good bargain. The ideal bargain occurs when the security offers a dividend yield among the highest of its history, coinciding with a stock price among the lowest of its history.

   In addition to the dividend yield over a 12 year period, Geraldine Weiss and Janet Lowe suggest 3 other complementary rules to help identify a good bargain in a quality blue chip stock:

   1- The price/earnings ratio must be particularly low for this security and, especially, lower than the average ratio of the Dow Jones Industrial Average stocks (the only exception to this rule concerns the growth stocks for which the price/earnings ratio is higher than their historical average, thanks in particular to record profits or unexpected from the analysts); 2- The company must have a strong financial health, i.e. a debt/equity ratio who does not exceed 50 percents; 3- The stock price should not exceed more than 33 percents of the company book value.

   These three criteria of value investment style are well studied by academic research; moreover, their meaning are not confusing.

   The owner of a security which offers a good dividend yield also wants to know if the profits of the company are high enough to allow a reasonable and constant increase of the dividend. If the dividend accounts for less than 50 percent of the company profits, it can be considered that there is still sufficient margin so that the company management can increase it in the future. With regard to the public utility companies, the bar can be moved up to 85 percents. In other words, the dividend can represent up to 85 percent of the profits generated by this type of company.

   What is called the dividend payout ratio (the percentage of the profits distributed in the form of dividends) can thus vary considerably from a company to the other. At the time when Geraldine and Gregory Weiss have published their work, growth companies like Disney, McDonald's or Wal-Mart had a dividend payout ratio varying from 14 to 16 percents. Other companies, not in such strong expansion, were allowed to distribute a dividend which eat up almost all the profits generated (Eastman Kodak: 86 %, Texaco: 92%), whereas some companies granted a dividend which exceeded the actual profits (Rafter: 105%; Dupont: 169%, Proctor & Gamble: 189%), which is extremely risky and even dangerous for the future of this dividend.

   According to the criteria elaborated by Mrs. Weiss to qualify a company of blue chip, 18 of the 30 companies which constitute the famous Dow Jones index failed the test. Only twelve companies passed the exam.

   André Gosselin

 
 
 
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