In today’s world of fast & online stock trading, growth stocks, penny stocks etc are in fashion. If I will talk about dividend stocks I am sure that most of readers will be bored. The reason being that either all dividend paying stocks are already saturated to an extend that even in long run they are less likely to give reasonable price appreciation. Trades will hate dividend paying blue chip stocks.
The price of these companies are comparatively very stable hence they are least interested. Even the medium term investors love some price volatility. Basically this whole stock market industry thrives and believes on short term volatility of stocks.
But value investors are slightly different, price volatility interests them only during buying but after they have owned the share, their focus shifts in observing ongoing business fundamentals of companies instead of its market price.
Till the company is managing its business/finances well and paying high dividends, value investors are than satisfied. Value investors only sees the market price during purchase as they only interested in undervalued, high dividend paying blue chip (value) stocks.
What makes value investors like dividends so much?
Dividends are not as fast ROI accumulator than growth stocks, but dividends has some advantages that outshines all advantages of growth stocks, small cap stocks, penny stocks etc. The consistency of dividends and probability of future growth can be known and estimated very accurately.
Whereas other investors who are investing seeing only market price are speculating and hoping to have future growth. But dividend payment is more closely related to performance of the company and managements philosophy.
Both of these business parameters can be defined, explained and analyzed in a more logical way than depending on speculations. In short value investors invests in stocks with dividends as their focus, eventually they get both (1) Dividends & (2) Price Appreciation.
When a value investors buy a share, they not only look at their undervalued price levels, but also look at the possibility of future earnings by holding that share for long term (say 15 years). In stocks market often you will find shares which has been wrongly priced by the market and hence they are trading at undervalued levels. Such stocks are favorite of value investors.
Upon locating such undervalued shares, immediately they look at their dividend payout ratio. Let’s assume a hypothetical company X which has $10 million as its net earnings.
Management has distributed 30% of its net earnings as dividends to share holders ($3 million). Number of shares outstanding in the market is say 1 million, hence EPS will be $10.
Suppose market price of share now is $100. It means P/E ratio will be equal to 10. Suppose every year the company increases its profits at the rate of 5% per annum. So let’s see how the dividend yield changes in these years:
| Year | EPS | Dividend Payout Ratio | Dividend Payment/ share | Purchase Price of Share | Dividend Yield | P/E Ratio | Market Price of Share |
| 0 | $10 | 30% | $3 | $100 | 3.00% | 10 | $30 |
| 1 | $11.20 | 30% | $3.36 | $100 | 3.36% | 10 | $34 |
| 2 | $12.54 | 30% | $3.76 | $100 | 3.76% | 10 | $38 |
| 3 | $14.05 | 30% | $4.21 | $100 | 4.21% | 10 | $42 |
| 4 | $15.74 | 30% | $4.72 | $100 | 4.72% | 10 | $47 |
| 5 | $17.62 | 30% | $5.29 | $100 | 5.29% | 10 | $53 |
| 6 | $19.74 | 30% | $5.92 | $100 | 5.92% | 10 | $59 |
| 7 | $22.11 | 30% | $6.63 | $100 | 6.63% | 10 | $66 |
| 8 | $24.76 | 30% | $7.43 | $100 | 7.43% | 10 | $74 |
| 9 | $27.73 | 30% | $8.32 | $100 | 8.32% | 10 | $83 |
| 10 | $31.06 | 30% | $9.32 | $100 | 9.32% | 10 | $93 |
| 11 | $34.79 | 30% | $10.44 | $100 | 10.44% | 10 | $104 |
| 12 | $38.96 | 30% | $11.69 | $100 | 11.69% | 10 | $117 |
| 13 | $43.63 | 30% | $13.09 | $100 | 13.09% | 10 | $131 |
| 14 | $48.87 | 30% | $14.66 | $100 | 14.66% | 10 | $147 |
| 15 | $54.74 | 30% | $16.42 | $100 | 16.42% | 10 | $164 |
Conclusion:
As an investors always look for following qualities in a prospective share:
(1) It shall be a blue chip stock
(2) It shall be undervalued stock
(3) It shall have high dividend payout ratio
(4) It shall have future growth prospects for its earnings (EPS)
At that undervalued price the dividend yield shall be at least more than 3%
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