How to Value Dividend Stocks
I'm not really a great fan of dividends but with the low yield on bonds, it may make sense to look at some dividend stocks.
When Warren Buffett $BRK.B is investing in a company (or buying the whole company), he wants the management to reinvest the profits, then buyback shares, and only in third place, to pay a dividend.
For example, Apple $AAPL with over $70 billion in free cash flow a year and over $200 billion in cash. They can only reinvest about $15 billion in R&D. About $75 billion was used last year to buyback shares and then. $15 billion to pay dividends. Dividends are always third on the priority list, especially in the US, where most of the big tech companies such as Amazon $AMZN don't even pay a dividend. In the UK and Europe, dividends are much more important to investors.
But if a company can afford to pay you a dividend, you should be happy that they are doing so. According to Benjamin Graham, in Security Analysis, you should prefer a cash payment (dividend) over capital gain and, therefore, you need to apply a dividend premium, called the Dividend Factor, when valuing the stock. For example, if 2 equal companies with the same earnings but different dividend yields of 4% and 6% respectively, you should be willing to pay a higher price for the second company, just for the dividend.
However, we should always make sure that the company can afford to pay a dividend. For example, ExxonMobil $XOM has a dividend yield of 10%. They can only afford this with debt and is unsustainable long-term. The same thing happened to Boeing $BA which was forced to cut its dividends eventually.
That's why it is important to do your homework when looking for dividend stocks instead of just looking at the dividend yield.
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