Dividends Count: Screening for Undervalued Stocks With Lower Risk

by John Bajkowski

Dividends Count: Screening For Undervalued Stocks With Lower Risk Splash image

The tumultuous market has many investors reconsidering the desired risk level of their portfolio and their overall investment approach. More conservative and traditional approaches to stock selection that fell out of favor in the bull market of the 1990s are back in fashion. Once again, dividends matter. Dividends contribute to returns in any market situation, while the income appeal of dividend-paying stocks helps to limit steep losses if the market declines. A dividend-yield strategy can help you find potentially undervalued stocks with reduced downside risk, provided the dividend is secure. Because mostly mature firms pay significant dividends, dividend analysis is geared toward established firms that are past their explosive growth and cash-consuming stage.

A stock’s dividend yield is computed by taking the indicated dividend—the expected dividend over the next year—and dividing it by the share price. For most stocks, the indicated dividend is the most recent quarterly dividend multiplied by four, although some firms have switched to a single annual dividend payment. If a stock is paying an indicated dividend of $1 per share and is trading with a price of $40, its dividend yield is 2.5% ($1 ÷ $40 = 0.025, or 2.5%). If a stock’s price rises faster than its dividend, the dividend yield will fall, indicating that the price may have been bid up too far and may be ready for a decline. Conversely, if the dividend yield rises to a high level, the stock may be poised for an increase in price, if the dividend can be sustained.

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