Are dividends yields a good measure of stocks value?
When it comes to direct ownerships of stocks, dividend yield is often a cited parameter in measuring the present value of shares of a particular company. We will look at all the factors using dividend when deciding whether a stock is a good buy, hold and sell.
Dividends are simply cash payments made by a corporation to its shareholders. The corporation may or may not be listed on a stock exchange; it may be of a different business entity that is not of a corporation.
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Successful businesses earn money of course. (In the same way like we equate a successful individual to one with high income and net worth) For the case of a company, there are only a few ways that the earnings can be used for.
1. Retire debts
2. Reinvest in existing core businesses
3. Acquiring related or unrelated businesses
4. Distribute to shareholders as dividends
How much to dispense to shareholders depend on only two objectives,
1. The most important of which is maximizing shareholder value.
2. Income and positive cashflows are in the first place belongs to owners of businesses.
The de facto rule of thumb is that if management is unable to invest retained earnings to generate higher returns than what stockholders could earn by investing the same amount in other investments of equal risk, then they should declare dividends to return earnings back to shareholders.
Subject to differences in stock markets in each respective country, you may want to use dividend yield as one screening point when choosing stocks in three general stock market scenarios. Because no one can safely predicts the future, one can only use historical data to estimate the future and assume that future returns will be around the same if same assumptions are still correct to a certain extent.
1. Invest for long term
I defined long term as 5 years or more. Look for the following historical data for all the companies listed on stock exchange concerned.
Total equity returns = capital appreciation + dividends income along the way – transactions costs
One must know that dividends for one year may not be enough to even buy something expensive but ten years or more down the road will be different.
Do take a look at all the companies listed, for those that give positive returns, most probably more than half of those returns come from dividends rather than capital appreciations for more than half the number of companies.
2. Start of a bear market
In this case, most listed companies will registered a negative equity return while you may check whether the percentage of companies with a dividend yield of minimum 4% that have achieved positive shareholders returns or less drop in prices at the start of a bear market.
If the value is large, such as more than 50%, choosing dividends yields of more than 4% may increases the odds of gaining positive returns if you unfortunately enter the market at the start of a bear market.
3. When market is bottoming
Of course no one can know where the exact bottom lies, if he can, then he no need to work already. It follows that for almost all stock exchanges around the world, investing at or near market bottoms will generate the highest returns.
But you may want to compare those with dividend yields of at least 4% to those of less than that even when the starting time is market bottom, using dividend yield as screening again most probably can significantly increases chances of a much higher returns.
What is the conclusion?
In conclusion, I personally felt that dividend yields functions well as stock price indicator as eventually an investor or investors as a whole demand for an existing business does not, and will not change the underlying economics of the businesses.
If dividends yield is high, stock prices will rise eventually to correct and vice versa. However, to take note that dividend yield as with other parameters, should not be used alone when deciding when to buy, sell and hold.
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The frequency of dividend declarations are a good sign of the value, especially for dividend seekers. However, you also want to consider the current value of the stock as well as the financial standing of the company. It also takes some predicting as to the potential of the company given the product and present trends. For example, I am looking at a stock in Mentor Capital because of it’s 20% claim in a biotech company with an innovative breast cancer treatment in the clinical stages that can boost the value of the stock price if it makes it to the market, which is likely since the clinical trials are being rushed through the FDA process due to the success they’ve had thus far. Because the treatment allows the immune system to fight cancer cells directly leaving healthy cells in place, the treatment will be favored by those who want to avoid the harsh side effects of other treatments. The treatment may also be recommended more by doctors. This will ultimately affect the value of the stock.