Analyzing Dividend Payouts
We’ve already gone over the danger of cancel culture, and we’ve gone over some good rules to eliminate risk. Now let’s look at ways of analyzing stocks for companies that pay dividends, in order to bring ourselves closer to being cancel-proof.
The dividend yield is the percentage of the current stock price that is paid out in dividends to the owner per year. If a stock is trading for $100 per share and pays $2 in annual dividends, then its yield is 2%. You might think of this as comparable to the interest rate in your bank account. A lot of dividends pay at a much better rate!
…the effects of compounding your dividends over time are higher if the initial yield is higher.
Some people emphasize that you do not want to pay too much attention to the dividend yield. There are some good reasons for this. Like I mentioned before, the yield is determined by the current price, and so if the price is merely an offer by the market, the yield is as well. It’s your job to see if the yield is justified by the fundamentals. Sometimes, a stock’s price can crash, and it might look like it pays a high yield (annual dividend is the same but stock price is much lower, so one could buy more shares with the same money for more overall dividends). If the crash is due to a major problem with the economy, then the dividend may decline or disappear. Until the company announces such a change, the yield will officially show up as high (these stocks are often called “accidentally high yielders”).
Through analysis, you can see if a company has the earnings and history to maintain its dividends in the face of hardship. For example, Aflac has increased its dividend every year for the last 38 years (through every recession) and still has a strong business model, so when its price crashed last spring, investors could trust that the high yield was actually going to be paid out for every dollar invested. For many other companies, this was not true.
Ultimately, though, the yield is important. The yield determines what will compound over time. If one is trying to beat the interest from their savings account or simply inflation, buying shares that currently yield less than 2% may not be the wisest move, simply because the effects of compounding your dividends over time are higher if the initial yield is higher. As your dividends come in, check the market for which companies have better yields. If your Aflac dividends would be better off reinvested in a different company that may now have a better yield, you might want to branch out a bit.
The Growth Rate
The yield gives one a good idea about what the returns could be with purchases made now, but if you hold a stock, then the future flow of dividends matters too, especially because inflation means that a stagnant dividend is technically decreasing every year! After looking at the yield, you’ll want to compare just how much the dividend is likely to grow, as this means your income will naturally rise as a stock owner and that your ability to compound your earnings will grow too!
There are a couple of methods I like to use when I try to calculate the future earnings of a stock, which I will go over now:
Per Share Growth
This is the most common way to calculate it. Look at the dividends paid per share over the last ten years to see if they’ve consistently paid dividends, for one. Macrotrends.net is great for that. To calculate the average dividend growth rate, take the current annual dividend and divide it by the dividend from ten years ago. Raise the quotient of that to a power of one divided by the number of years (10), and then subtract one to get a decimal. It looks like this:
If you need to find the dividend history, most companies will have it listed on their official websites. Usually there is a section labeled “investor relations” that you can follow.
Usually I then try to find what the total dividends paid in ten years should be. Using the growth rate (g), you can use the following formula to calculate the total payout.
Keep in mind, using a discount rate might be wise for analysis and to help you in strategizing. I’ll cover that some other time, but Investopedia discusses it.
Total Cash Growth
This one is less common but still useful in analysis. Look at the annual reports (they are all searchable here)of a company for the last ten years. They should should tell you how much cash was paid out in dividends each year. This is not the same as the dividend per share. This is the total pile of money that the company was willing to give up and return to the shareholders, whatever the dividend happened to be that year. Be careful that you are only counting total dividends paid to common stock owners too!
You can find out the average growth rate with the same formula above (2021 Cash/2012 Cash). Then find out what the average cash per year was, and calculate its growth using the second formula above. After that, you can just divide that number by the total number of shares in circulation. That projection of dividend payouts will be different than just projecting growth rates from the current dividend. It will usually be lower but may be higher or about the same.
These two calculations can help you assess a company and get an idea of the range of possibilities. If both calculations show that you will get strong returns, then that’s a good sign. I personally look for companies that will pay me back around 50% of my principal in the next decade and that show a chance of beating inflation each year. If a company’s price rises, they may no longer have this kind of return, so vetting the company like this can help me know if I should just hold or if I should reinvest my dividends into it, in order to accrue more shares.
Now, I own some of Aflac, so I’ve done some analysis already. Using the methods above, I calculated that that the growth of the dividend per share should give me a return of $18.77 in ten years. Looking at the cash payouts, I calculated a return of about $9.72. Closing at a price of $46.31, this gives AFL a projected, ten-year return between 21% on the low end and 40% on the high end,. If we invested $10,000 into Aflac, we’re looking between $2,100 and $4000 in earnings, which isn’t bad.
Now, this doesn’t calculate the compounding effect of reinvesting the dividends, merely what holding the same shares over ten years could do. While I mentioned earlier that one should actively be reinvesting based on the best prices on the time of the purchase, let’s go ahead and calculate the compounding effect of reinvesting Aflac dividends over ten years. Remember, dividends are usually paid quarterly (sometimes monthly), so that gives you more chances to compound. If I only bought AFL and reinvested, assuming the current dividend and the growth of that yield holds, a $10,000 investment would produce about $4,650 in earnings, giving a return of about 46.5% instead! Not only that, my annual dividend income will have increased from $289 to $707 per year.
Now just imagine that you’re actively adding more money from your regular paycheck, and soon you have a lot of compounding going on. By growing your own income through shrewd investments, these dividends will bring you one step closer to being cancel-proof.