In the last entry we talked about the second factor to consider when buying a stock – the dividend rate. My overall goal is to develop a stream of income from my portfolio and collecting regular dividend payments is one way to do that. I buy companies on the S&P 100 which pay the highest dividend rate. In this entry we’ll move on to step 3.
Let’s go back to our analogy. I’m trying to buy a new piece of camping gear and I’ve decided to go with a well-known supplier. I’ve chosen a good quality piece of equipment (companies on the S&P 100) that will last and add value to my hiking experience (companies that pay the highest regular dividend). Being a frugal person (some friends would say ‘cheap’) I’m going to wait until the item I want is on sale. Why pay more than I have to right? If I wait for a sale I can get the same item for less!
When choosing a stock, I apply the same principle. The good news is, with so many companies on the S&P 100, there’s nearly always something on sale. You might be wondering what on earth I’m talking about when I say a company is on sale. Let me explain. I figure a good way to estimate the value of something is to see what people are willing to pay for it. This is true of camping equipment and stocks alike. It’s easy to see what people are willing to pay for a stock because that’s what the current trading price is. We can see from the image above that Walmart was trading at $61.30 per share on December 31, 2015.
Ok, now we know what the current price of a stock is but how do we tell if that’s a sale price or not? Easy! I look at the maximum price people were willing to pay over the last year (called the 52 week high) and compare that to the current price. Pretty simple, right?! Again, I find that price for every company on the S&P 100 and calculate how far below the 52 week high the current price is. Let’s look at an example.
Basically, people were willing to pay $66.36 for this stock within the last year and I can now buy it for $33.49 – a discount of 49.5%. This is a solid company on the S&P 100 so, chances are, it’ll be back to that high within a year or so and I will have realized a 98.1% return. Oh yeah, and collected my 5.49% dividend in the meantime. Sweet! Would you be excited to buy something you think is valuable at that kind of discount? Of course, you would!
Just like with the dividend rate, I assign a score to each stock depending on how far below the 52 week high it’s trading. In other words, I look to see which stocks are really on sale. That score is added to the score the stock earned from its dividend and I’m one step closer to making a decision.
