IFB13: The Unreliability of Forward P/E and 10% Dividend Stocks

dividend yield

Welcome to session 13 of the Investing for Beginners podcast. In today’s session, we have a Q&A with Steven about many different topics, but the two main items for discussion are the forward P/E and 10% dividend paying stocks. Calculating a forward P/E can be tricky and relying on the financial websites to do it for you can be risky, they are not always using the most relevant data and sometimes rely on analysts reports. This is risky because the analyst’s data can be skewed by their biases, which can lead you astray. We discuss this and much more.

  • How to find great investments using the Value Trap Indicator, even when the investments are months old
  • The best financial websites to find the most up to date data to calculate a P/E
  • The fallacy of using a forward P/E and how the analyst’s data could be biased
  • Are companies paying a 10% dividend risky?
  • How to find safe, reliable dividend paying stocks

How would I know if any of the choices in Andrew’s eletter would be good investments now?

Andrew: Well, I have a good, nice and easy answer for you. That’s the good news, first off a hot tip for a fellow Californian, I bet it’s beautiful out there right now. Basically, if you look at the eletter portfolio and you will see all the positions like you said it shows what date I recommended it and then I also show what the price was when I recommended it and what the current price is now.

On that second to the last column, you will see a return percentage and that shows you much the stock has returned since recommendation. And all the stocks that are on there are going to be a hold unless a stock triggers a trailing stop or if I’m trying to take some profits then we’ll go ahead and activate a sell. But a majority of the time all the positions are going to be a hold.

And what I would do if it was me starting over trying to build a new portfolio I would try to build these positions slowly over time and if I was trying to buy maybe buy more than one position at a time I would just look at the stocks that haven’t appreciated yet, as in haven’t made any significant gains. I am looking at the portfolio right now, many of the stocks that have really high gains you are going to want to stay away from because those, not to say they won’t be great investments in the future.

But the main premise of the kind of investing that Dave and I like to teach is buying stocks when they’re trading at a discount to what they are really worth. Although a lot of these stocks still might be at a discount, if they’ve already seen an uptick in the price you likely aren’t getting as much of a discount. With every single stock on here, we are trying to get a discount. Any stock that hasn’t really risen that much is likely still within that discount range. I’ve got stocks on here, there’s one up 31%, 86%, 13%, those you probably, generally want to stay away from, see if they dip lower. There’s stock on here that’s down 0.8%, and there’s another one that down 9%, stocks like those are still going to be good buys today because they are trading at around the same as when I recommended them.

I’m constantly reevaluating these stocks as new data comes out. I tend to do that at least once a year, for many of these positions. If I haven’t triggered a sell and notified a sell on the eletter issued then you’ll know that these stocks are still, they have a good premise of why they should be bought or held. There’s a couple in there, a good group of maybe three or four where the shares haven’t really gone up too in price, so they still make a good buy point.

Can you tell me about the ratios on the finance websites and are they correct, and how would I find the correct numbers?

Andrew: Really every financial website is going to have a different calculation for PE, and it’s not that the data is really changing or anything like that. A lot of the financial website like to make that calculation based on forward projections of earnings instead of previous projections. What Dave and I really like to do is we like to look at numbers that aren’t likely to change. I mean there not going to change at all. For example, a company releases an annual report, wich is the source of where all the websites get their information from.

So, a website like Yahoo or Google will be taking those earnings but they won’t be looking at the annual report per se, they will be looking at analysts estimates. We know that the likelihood of estimates being accurate is really kind of. It is such a crapshoot when it comes to a lot of these estimates. Just turn on the news or CNBC when it’s earnings time, which coincidently as we record this there have been a lot of companies like United just recently released their earnings report. It was kind of funny because everybody talks about all the things that they have to happen to them lately, with the guy getting dragged out, I heard a scorpion fell on a passenger, and they came out with all the apologies upon apologies all throughout their earnings calls. I thought that was kind of funny, the earnings reports, and again if you look on the news they are missing on these estimates all the time.

When a website quotes a PE and is using forward earnings, they’re likely going to be miss evaluating that. Another website like Finviz does like twelve-month trailing and I guess it really depends on the company. I say all this and it’s a lot of like I tend to do, just barf out and puke out all this sometimes irrelevant information. So the PE you will see on Google or Yahoo, it’s not going to be a 100% accurate it will be within a certain range where you kind of feel confident that this is a good picture of where the PE is.

But every once in a while you will see a situation where analysts are completely wrong and that PE ends up really getting blown out of the water. As an investor, you have a couple of options, if you’re really looking to dig into the numbers and if you want to find a PE and you are trying to really pinpoint it. You are trying to sew the pillows to secure the area versus the large animal that is already with us. You are trying the use the PE to try to pin down a stock price if your going to buy a stock or not, and it’s something your trying to get a solid valuation on, then your going to want to go the source, your going to want to annual report and your going to want to look at earnings that are already posted.

Real data, not data that is estimated and that’s why we tend to use the trailing PE. That’s not to say that the PEs on Google Finance or Yahoo Finance aren’t useful at all. I think in that situation it can be a great thing for if you’re just maybe trying to get ideas for companies or really in that initial stage where you’re trying to make general comparisons and see. for example if a company like Amazon (AMZN), our whipping boy and look at their PE or even the forward based PE it’s probably really high. So, a quick thing like that putting Amazon into the Google Finance will show you that with such a high PE there’s no point in doing research any further, and that is how that can really be a great tool as you’re trying to learn.

Steve, you mentioned that you just started two weeks ago so I’m really throwing the fire on you when you’re just trying to get a little flint going. I would just say don’t worry too much about if the PE is using forward or trailing when you are just starting to wrap your head around it. Understand that later on if you’re really trying to get precise that the Google Finance and Yahoo Finance is a good starting point and if your the type of investor who really likes to dig in and get really specific and that’s when you’re going to want to graduate to the annual report.

Dave: I would like to add a little something to what Andrew was saying too. With the ratios that we talk about in our podcasts and the blogs we write and the ebook that Andrew has written, think of those as measures that you can use to compare it other companies as well as a screening tool to find companies that you would want to do more investigation into to before you’d buy it. a PE is a great place to start, it’s kind of an overall metric that can give you a snapshot of the financial health of the company.

I would never, ever recommend you buy strictly on that one metric because there is so many other things that ar involved in buying a stock and could trip you up and cause you a lot of problems. Like Andrew was saying the websites are going to give you a good reference point and in your situation where you don’t have a lot of time to really digging into those numbers at this point then using those financial websites is going to be a good reference point for you to get started and to kind of get your feet wet and to understand how these ratios work, and to kind of use those as comparisons.

I think the biggest thing like Andrew was saying talking with our good friends at Amazon. And anybody out there we really like the company but we just don’t want to invest in it. With that being said, use the ratios as a way of finding something else you’d want to dig into. If you look at Apple, Netflix, Google, Facebook or any of these companies that are well known, you can see a wide range of PEs and as a value investor we are always looking for ones that are going to sit in a certain range and if we see ones that sit outside of that range then we move on from there. We say ok and that’s too rich for my blood, so to speak and we are going to move. I guess that is how I would look at using the PE ratio as well as the other ratios.

If you find a company that you really like and you think it’s a great investment and you look at the PE ratio and it’s way out of whack, maybe from you’ve seen in the past then maybe that’s something you might want to investigate further, or if it is too rich and too expensive, then move on because it is not worth it. Does that help?

forward p/e

Steve: Could you give me your insights into companies with really high dividend yields? I am almost 50 and have started late on retirement and am looking to play catch up and these types of companies are appealing to me because they could pay me income in my retirement.

Andrew: Dave, age before beauty.

Dave: Well, Steve I am right there with you. I am actually 50, so I am the oldest person in the room so to speak. And I understand where you’re coming from with those companies. My thought is whenever I see a website or a blog or some advertisement that is advertising buy these ten stocks. I always enter that realm with a bit of skepticism because I wonder what’s in it for them and where is this coming from.

When you start seeing higher dividend yields like that you have to think how about how a dividend functions. A dividend functions basically as money that the company has decided not to use either to reinvest into the company or pay down debt, or other projects that they have. Instead, they have decided to give it to the shareholders. So, a 10% yield is quite high and when you start thinking about that ratio and it depends on what type of company it is.

When you are talking about financial companies or retail, or some other line of business there are all going to have general ranges that they are going to sit in as far as what’s comfortable for them to continue to function and operate their business. When you see a high dividend yield like that, the first thing that pops into my head is where is that money coming from. Is it coming from the operations of the business and they’re just choosing to turn around and give all back to us, which is obviously great. Or are they doing other things like financing it, are they getting money from other sources other than operations of the business to pay that out. Or has the stock price dropped so much that the yield that they are still continuing to pay because they haven’t changed their policy as of yet, so now the yield is a lot higher?

Those are some red flags or warnings signs that would go off for me. The flip side of all this is like you said you are feeling like your playing catch up and kind of behind the eight-ball a little bit, so you’re looking for higher yields on things like that. There is another option out there in the world of investing that you can get into that will have higher yields and still be safe investments because nobody wants to run out and chase yield, looking for these really high paying dividend stocks and then have the company go bankrupt. Andrew has a whole system that he’s built that helps you find these kinds of companies that we will talk about that specific thing. And it’s a great resource to have and I’ve used it as well.

The thing that I am trying to drive at is this, I would be very, very wary of those kinds of companies. You know, there are stocks that do pay high dividends, besides Dividend Aristocrats who are great companies to invest in, they are not going to have yields that you are going to see like that. But you can look at REITs, and I am not super familiar with REITs I’ll be honest with you. I have done some research on them, and it is not an area of expertise where I feel comfortable talking extensively about. But I do know that there are great buys in REITs and there’s a lot of different metrics that you have to look at that are a little bit different than say, looking at Wells Fargo, or Walmart. I guess my point with all that is there are options out there but I would be very wary of the websites advertisements. do your research before you buy anything like that, I would never just take it on the word of some guy that has written 27 words about a company that he’s not really done any research on. Does that make sense?

Andrew: Let me say something about the REITs. If you look back at my previous issue, which by the way if you subscribe to the eLetter you will get a copy of every single back issue I’ve ever written. So, if you look back at the May 2016 issue, that issue had a REIT that I recommended and basically when it comes down to REITs and this going to come down to the same kind of thing when you talk about stocks with high dividends and yields at 10% or above. IT’s not so much the yield that we need to focus on, it’s the aspects around the yield. So Dave brought up a great point, is the dividend coming operations, if operations are strong and the core of the business is strong, then we can be fairly confident that the dividend should continue to be paid out and the company won’t go into too much debt to pay it out. Another way to kind of evaluate that is to look at a long-term picture and see, which I have probably mentioned in the last 3 issues that have been published has been this really big focus on really looking at the very long-term. The last thing you’re going to want to look for, make sure the core business is solid, make sure over the long term things are progressing in the right way.

Because guess what you buy a company that is yielding 10% and you might get a great first-year dividend but if it is a declining business and a declining industry or you know a company that is just piling on debt and setting themselves up for financial armageddon. Sure, you might get that 10% payment up front but if your stock loses 25% in the first year, which is the types of things that I’m always actively trying to avoid and why the focus is so much on limiting downside risk. then suddenly you’re in a much more terrible spot if you would have just bought some boring, slow, consistent company that maybe it’s only paying 1% dividend, but its dividend is growing over time and you are collecting shares over time and likely not losing 25% in a year like some other more risky businesses.

The last thing you are going to try to look for is if a company has a high dividend yield it could be a good indicator if the share price has been unfairly dropped and the markets been unfairly pessimistic about it. As a stock price drops that yield naturally becomes higher because that dividend only changes once a year but the stock price can fluctuate all throughout the year. If you are coming into a time period where the stock is going through a 3 or 6-month rough patch that yield could be really high during that situation. Maybe in that case actually buying at that high yield could be a great thing. And I know you talk about Ben Reynolds and we’ve had him on and he’s been a friend of mine for a good amount of time and I like everything he’s doing at Sure Dividend. I know he combines and looks at things like core business. A big thing that he also looks at is to make sure that he’s getting the stock at a good price.

And that kind of goes back to everything we all try to teach is that you’re going to want to buy a discount to intrinsic value. Keep in mind that I don’t know what kind of advertisements competitors are trying to push on people. I know a lot of it can be hype and there’s so much out there e you can’t sanely keep up with it all, But I’m sure there’s a great percent of that 10 % yielding stocks that either are really expensive and completely overvalued or propping up the dividend through debt and that is why you want to take a complete picture. Want to make sure everything is in place and as Ben, Dave, and I like to do buy at a price that is favorable for yourself.

When you are buying a company that is having that 3 to 6-month pessimistic short term kind of little stumble. That naturally results in companies that are more attractively valued and more attractively priced and likely have a greater discount to their intrinsic value, which in turn has a greater probability than not to give us nice returns. And that is where the whole premise of value investing starts and ends.

Now, one more thing about REITs to understand is that by law they are required to pay a majority of their earnings a dividend. The kind of consistent dividend growth you see from most other dividend payers, the Dividend Aristocrats companies like that. Those REITs are going to have that same steady consistent, growing dividend stream because since the amount of dividend is mandated then earnings aren’t going to perfectly grow for almost all cases. Earnings fluctuate throughout the years as the economy fluctuates. The dividend payment will continue thru the earnings drying up. And that dividend payment will fluctuate as well. Keep in mind the difference between a REIT and a regular stock is that a REIT is going to pay 90%. That is going to fluctuate year after year. If they are growing their dividend over the last 5 years and likely they are not going have that kind of history. you are going to want to put less of an emphasis on things like the payout ratio, which we talked about two episodes ago. It’s fixed at a 0.9, so don’t look at that. but you’re really going to want to be more stringent about everything else because you have to understand that the earnings can really fluctuate which could potentially mean that if you are getting a REIT at 10% now. And you could be paying a and next year it could be a 2%.

From a yield perspective the actual dividend gets paid out. in a regular stock, it is very rare for a company to cut their dividend. They’ll usually either maintain it or make it grow, whereas a REIT is just going to be all over the place.

Diversification would depend on how many opportunities are out there. I’m honestly finding that is harder to find opportunities in REITs. If you take an outside of the stock market view at real estate, in general, you see companies that like to use debt or leverage tends to gravitate towards that space. A lot of REIT themselves carry with them a lot of debt which as we all know that creates a lot of risks. Sometimes it can be hard to find a good REIT that gives you low enough risk to make up for everything else and to make it an attractive stock purchase. Like you said you definitely don’t want to be 100% REITs and the same way you don’t want to be 100% oil stocks.

How does the dividend yield work? Is it based on the price or earnings of the company or how many shares I own?

Andrew: Yeah, so you’re talking about the yield percentage? Or the dividend number? I mean it comes down to how many shares you buy. Let’s make it real simple a stock is trading at $100, we are going to invest $100 so we buy one share and the yield is 3%, that means it is going to pay out a dividend of 3% of $100 which is $3. so if we had 10 shares we would get $30 of dividends every year if we just had one share then we would get just $3 in dividends every year or 3%.

Obviously, every situation is different every stock buys individually is going to be different. that yield percentage is going to change every day on Google Finance or Yahoo Finance but the basic premise of it is that you’re going to buy a stock and you’re going to spend however much money on it as you want to invest. And you can basically reasonably expect to get whatever that yield is paid to you for that year. If the yield is 4% and your buying $500 worth of stock you’re going to get 4% of that $500 paid back to you. Whether the stock is trading at $2 a share or $20 a share, you’re still going to get 4% of $500 because if you’re buying at $2 a share you’re buying a lot more shares to make it to $500. If the stock is at $20 a share you’re going buy fewer shares but in the end, it is going to be the same because the percentage is there.

To answer the second part of your question about the dividend column that I have. That’s a little bit different because I am tracking the portfolio every single month and updating it every month, so the current price is changing every month. The dividend column that you see is how many dividends I’ve received as long as I’ve held the stock. the top company on there has $0.39 of dividends and it’s one of the lower dividend paying stocks but I’ve held it since 2014. So that means I’ve collected dividends in 2015, 2016, and the first quarter of 2017. For every dividend I collected I added it to the dividend column. I know it’s kind of confusing over their airwaves if you will. That dividend is calculated as if you were to buy one share. I know some of the stocks are trading at $12, another one is trading at $100, so they are going to have more or fewer dividends paid out based on that. but as an investor, I guess the yield would be more important for you because that’s more personalized too, however, much you’re investing and it’s not going to care whether the price is at $100 or $12.

In the case of my eLetter table and the portfolio as it is presented it’s because I am doing the calculations on one share. You could just ignore the dividend column and just look at the return percentage to the right of it and that’s is going to tell you what the overall return is. It’s giving the difference between what the price is now to what the price was when I recommended it, plus whatever dividends I have collected along the way. And that’s going to give you the percentage. That dividend column for people you just want to track on their own and see that number grow over time. Take that first percentage and if I divide $0.39 by the initial $108 it’s about 0.08%. You can always calculate the yield and you can calculate how much the yield you have collected along the way.

That is basically what I am trying to do with the eLetter is show how many dividends have been collected over time and then from there, you can do a calculation to see how much of that’s really contributing to the overall return. In reality, if you’re reinvesting the dividend over time then you’re actually collecting more share and earning more dividends on those shares. Your results are actually going to be higher as time goes on. there are a million different ways to track it and the core concept you’re going to want to take home is that if it is a percentage it’s talking about the percentage of however much you want to invest.

Generally, if a website is talking about a dividend paid as in a $2, $0.35, or $0.25 their almost 100% going to be talking about how much in dividends they are paying per share. I hope that helps.

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