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Mom's Method of Stock Research: Part Three
Linda Goin
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We can't believe January is history. Sheesh! Before I know it, Cora will be old enough to support me. Before we go into that topic, we have more information to cover at BUYandHOLD. Surf back to your company's page through the stock research section, and find your company's "Company Profile" page.
Go to "Dividends," halfway down the page and to your left. Your company may periodically declare cash and/or stock dividends. If you see a dividend here, it will be listed as a year average. The annual dividend is determined by adding four quarters of payouts. For instance, if your company pays $2.65 per share the first quarter, followed by payments of $.50, $.25, and $167, your annual dividend would be $5.07. Your average quarterly dividend would be $1.27. This is the annual dividend divided by four.
The yield is the dollar amount of the annual dividend divided by the current share price. In other words, if you purchased 100 shares of stock, the current price is $10.00 per share, and their average quarterly dividend is $1.27 per share, your pre-tax yield is 0.5%. If your federal taxes are 30%, and state taxes are 5%, your after-tax yield would be 0.33%, or $.83 per share.
Yes, Virginia, dividends are income, and these payouts incur taxes. If you have a portfolio at BUYandHOLD, you'll see a little box you can check to reinvest your dividends. When you check this box, you tell BUYandHOLD to reinvest this stock's cash dividends back into that stock. Otherwise, you will most likely receive the dividend as cash in your account. Please note that the dividend is counted as "dividend income" on your taxes.
Quarterly payment of dividends is more common than annual or semiannual dividends, and many companies don't pay dividends at all. Your company's Board of Directors decides if it will declare a dividend, along with frequency and the dates associated with the payment. These dates are important. If you want to own a stock that will pay a dividend, you must own the shares when they close the books on the Record Date. To assure ownership of the stocks by that time, you must buy them three days before the Record Date to be declared a shareholder of record. The Distribution Date is the date the payment is made. If your company doesn't pay a cash or stock dividend (split), don't fret. The company will usually calculate their earnings first, and then decide what to do with these assets (or liabilities). They may decide to retain the earnings for lean times, or to reinvest the earnings into expansion of the company. Always dig into your company to uncover how they manage their assets.
This brings us to "Management Effectiveness" to the right of Dividends on your Company Profile chart. The title says it all - these two figures will tell you the effectiveness of the company management. The "Return on Equity" or ROE is - on the most simple level - the yearly net income of the company divided by the book value of the stock (see last week for book value).
This figure is one way to discover if your company is an asset generator or a cash pig. If the figure is in the minus column, go to the news to see what's happening right now (or six months ago). If the company is young you might expect a negative figure, as they could reinvest assets in the first three years of operation.
These figures are percentages, so if you see an ROE of 26.75, this means the company creates 26.75 cents of assets for each dollar originally invested. Note the age of your company - a business with older assets might show higher percentages of ROE than a business with new assets because replacement costs aren't figured into the final equation. Be sure to take note of the Return on Assets (ROA). If the company has high ROE and low ROA, you can almost bet your bottom two cents the company is in debt. This might not be a horrible thing - some companies run on debt, as they need heavy reinvestment in equipment and supplies. This usually doesn't spell high dividends for the investor. But, if you own stock in a company that is reinvesting assets and you're agreeable to this process, you might see a nice payoff down the road. Keep an eye on company expenditures, however.
For ROA, divide the net income by tangible assets. If the result is low, the ROE is low. Simple, right? Well, a low figure might also mean a slow turnover of assets, or a reinvestment in assets. Or, it might mean the company is in debt, period.
On the other hand, high ROA measures management's ability to produce income from the company's assets. A company that doesn't need high capital investment in services or products will show higher ROA than a company that replaces assets consistently. Usually, high ROA means high profit margins.
If you glance down to the bottom left, you see your company's "Financial Strength." A "Quick Ratio" is current assets minus inventories divided by current liabilities. Inventories might not sell for purchase price, so if your company is forced to liquidate inventory to meet expenditures they may face losses. You might see an altogether different figure than you would see in the Current Ratio, which is current assets divided by current liabilities (without the inventory figure).
A 1.5 is usually adequate for liquidity on the Current Ratio. If you see a higher figure, it could mean the company is hoarding money. A seasonal business might have a high current ratio to help them through an upcoming slow season.
Please, please, please always compare figures. Don't place individual calculations on a pedestal for your decision-making process. If you compare ROA and ROE to the overall profit margin and financial strength, this method is a sound way to compare your company to others in the same sector. If a company consistently shows high ROA and ROE over a period of time, along with high profit margins and dividend payouts, then your ROI might be dandy.
ROI? That's your Return on Investment, and we'll cover the possibilities next week. Hold onto those stocks and the seat of your pants, because we're in for a wild ride on a horse called "common cents." (I know that sounds corny, but Cora likes it.)
Until Next Week,
Linda Goin
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