Even the best dividend stocks are not worth buying at any price. The price you pay is very important to your long term returns.
So how do you make sure you are not paying too much? They are plenty of complicated financial models that analysts love to use but it doesn’t have to be that difficult!
Here at Dividend Freedom, I use dividend yield and the price to earnings ratio to make sure I don’t pay too much for my companies. Simple and effective!
Let’s start with dividend yield...
Calculate the 10 year average dividend yield of your prospective company. You do this by looking at the historical stock prices and dividends paid from the earnings reports on the company’s website. Just make sure you're using the total annual dividends paid.
When you have the information in front of you, calculate the average dividend yield for each year. Once you have the yearly averages, use them to get the 10 year average.
NOTE: You should not include periods of recession in your 10 year calculation as that will bring the average yield up artificially. For example, with the recent market crash in 2008 being within the last 10 years, we would use the period between 1997 and 2007.
Once you have your 10 year cyclically adjusted dividend yield calculated, set that as your benchmark for buying the best high paying dividend stocks.
I only buy when the current dividend yield is ABOVE the 10 year average. This ensures that I am always buying at value prices.
Now for the price to earnings ratio...
Do the same thing with the price to earnings ratio and calculate the 10 year average using data from the company’s website. Once you have your 10 year average, just like with yield, use that as your benchmark.
I only buy when the price to earnings ratio is BELOW the 10 year average.
In general, when the dividend yield is above average the price to earnings ratio should be below average. But because earnings can be manipulated, it is possible that the above won’t hold true. For this reason, I predominantly rely on yield and use the PE ratio as a check.
Congratulations! You just learned a very important lesson that will help to make sure you don’t pay too much for the best dividend stocks!
Return from How to Purchase the Best Dividend Stocks for the Right Price to Our Strategy for Dividend Investing Success
Return from How to Purchase the Best Dividend Stocks for the Right Price to the Dividend Freedom Home Page