Yield Difference as a value indicator
Posted by BM on April 18, 2021
We use yield as one of our key value indicators. The current yield, however, does not tell you much unless you have an idea of a specific company’s historic yield. This logic is based upon a theory that has been around since at least the 1960s (Dividend Yield Theory) and was popularized by asset manager and investment newsletter publisher Investment Quality Trends, known as IQT.
Dividend growth investing has been a great way to grow both your income and capital over time but that does not mean that you can buy any stock at any time and expect to do well. Overpaying, even for a quality dividend growth stock will minimize your future returns.
Warren Buffet is quoted as saying that “it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price”. But how exactly do you determine what a “fair price” is?
We use yield difference to screen for candidates.
Dividend yield theory is simple and intuitive. It basically says that for quality dividend growth stocks, meaning those with stable business models that do not significantly change over time, dividend yields tend to revert to the mean.
In other words, a stock’s dividend yield fluctuates around a relatively fixed level over the years that approximates fair value. If the stock’s current yield is far enough above its historical yield, then the stock is likely undervalued. And if its yield is beneath its historical norm, then the stock could be overvalued.
While the dividend yield theory has proven to be a useful valuation tool in many situations, it is important to realize that it works best under long-term conditions (5+year time frames) and with quality dividend stocks that possess (1) secure dividends, (2) generous payouts, and (3) stable business models.
Source Simply Safe Dividends
Here is ‘The List’ in yield difference order as of April 16, 2021. YLD_DIFF-The List-04-16-2021
A couple thoughts from this report. ‘The List’ has already been screened for dividend growth stocks of above average quality. We get our ideas for stocks to buy from ‘The List’ that are above or close to the bold line. From there we drill deeper into other value indicators and future estimates of growth before we purchase. Having a screen based on dividend yield theory can help us minimize our chances of overpaying for most of the stocks on ‘The List’.
Thus, a quality dividend growth stock’s historical dividend yield can provide a reasonable fair value indicator that you can use to ensure you are buying wonderful companies at a fair price or better.
