Recently, some of America’s big corporations have been cutting or eliminating their dividends.
As an investor, I would like some income with my investment dollar. Dividends help recover the initial investment. For companies that do pay dividends, the current yield is an easy and ever present method to check and compare stock returns.
One method I sometimes see recommended by investment guides and books to evaluate dividends is to compute the present value of stock dividends out for ten to thirty years.
How to Evaluate Stock Dividends
Everyone understands present value if they remember the terms of their car loan or home mortgage.
For someone who borrows $100,000 to buy a home, the loan is figured in monthly payments: usually for 30 years, although any years or months will do. Using the current interest rate for Treasury bonds at 3.3% as a representative market interest rate, and the payments come to $437.96 a month for 30 years. [Calculations with MS Excel function PV(.033/12,360,437.96,0,0)]
In present value parlance, what there is right now, $100,000, can be translated into a stream of monthly payments of equal value. But the reverse is also true. Monthly receipts can be translated back to an equivalent value, which gives a method to evaluate stocks.
Monthly receipts of $437.96 for 30 years are worth $100,000 at 3.3% interest and thirty years.
Since dividends are a stream of payments, they can be translated into present value and a measure of stock value. At the beginning of last month, Eli Lilly (LLY) traded at $34.90 with a $.49 quarterly dividend.
At 3.3% interest for 30 years, that stream of dividends has a present value of $37.99. Eli Lilly is trading below the present value of its dividends. In a long-term retirement account, the dividends will buy back the stock.
IBM traded at $117.93 with a $.55 quarterly dividend. Using 3.3% and 30 years, the stream of dividends has a present value of $41.79. IBM is trading well above the present value of its stock dividends. In a long-term retirement account, the dividends will not buy back the stock, even in 100 years.
Will Dividends Buy Back the Stock?
Many companies brag about their record of unbroken dividends for 10, 20 and 30 years, which helps me predict whether dividends will buy back their stock.
Dividends and long-term interest rates tend to be much more stable than stock prices, which gives me more confidence in the present value comparison.
In my personal investing, I like to compare present value of dividends with market value and I do not allow automatic investment of dividends.
Owning stocks is risky and comparing the present value of dividends with market price doesn’t eliminate the risk, but it helps me separate stocks like IBM, which must have capital gains to make money, from Eli Lilly where their dividends will eventually cover my investment.
About the author: Fred Siegmund covers America's jobs as part of work doing labor market analysis and projections for a client base of recruiters, trainers and counselors. Visit him at www.americanjobmarket.blogspot.com
