Personal Finance 101

Written by Tyler |

What We Have Learned 

It is very important when investing to not only evaluate a company against others in its sector or industry, but also against itself.

In previous articles, we have discussed the dividend payout ratio, free cash flow, Z-Score and Return on Invested Capital (ROIC). All of these metrics are used as a way to evaluate stocks against their peer group, but also against themselves at different points in time.

When we have narrowed a company down against its peers, it is then time to evaluate the stock against itself at different points in time. Doing this can help us to determine if a stock is selling at a reasonable price.

How To Use Average Dividend Yield 

One of the greatest ways to evaluate a dividend stock against itself is to determine the average dividend yield that that stock has paid over the past number of years. If the stock has a higher than average yield, compared to its historical average, then it may indicate that it is a better time to purchase shares (all other factors being equal).

There is an excellent tutorial on calculating average dividend yield at DividendsMatter.com. I will highlight some of the main points here, but I highly suggest that you read the full tutorial.

First of all, I like to gather 10 years worth of data for the stock. This is easy to do because the stocks that I analyze have very long histories of paying dividends. The information we need is the high and the low stock price, and the dividend paid out for each of the last 10 years.

This data can be gathered from many sources, including the company website.  However, I prefer to use Yahoo Finance because the dividend information can be filtered out from the stock price using this option.

This is all the historical information we need. Now, from this information, we can calculate the high yield and the low yield for each year. The high yield is calculated by taking the annual dividend and dividing by the low price. Similarly,the low yield is calculated by taking the annual dividend and dividing by the high price.

High Dividend Yield = Annual Dividend / Low Stock Price

Well Worth The Effort 

The mathematics of the process is very elementary, but it does take some time to gather the information.  This is certainly time well spent and I suggest that you practice on a couple of your favorite stocks. 

You will find that buying high quality, dividend growth stocks at prices above their average dividend yield will give you a margin of safety and confidence to hold the stock through thick and thin.