Hi, I'm Jimmy, in this video I'm going to walk through how to value a dividend stock
with some fairly simple math.
The goal of this video is to have a quick and easy way to help guide us as to how much
we should pay for a dividend stock.
And ideally our dividend portfolio can one day help us help provide us passive income
and give each of us the financial independence that we're after.
Okay.
So let's jump in to look at some examples.
So I've got two real life examples where you'll look at the genuine parts company and Apple.
Now, I actually did a more in-depth video on this formula, which is called the dividend
discount model.
I get a link in the description below to that more in-depth video.
This video is going to focus more on the application of this and how to use it quickly and easily.
And we're gonna use actual companies so we can do a better job of estimating with a fair
value of a dividend stock is that way.
We never overpay for a dividend stock.
OK.
First, we need the current dividend.
For that, we're going to use the dividend over the past 12 months.
How much is the company paid out over the past 12 months?
Then we need the dividend growth rate.
And then the final thing we're going to need is each of our own required rate of return.
Okay.
Simple enough.
Now, let's put all this together and we could separate the genuine parts company.
Over the past 12 months, genuine parts has paid a dividend of about three dollars a share.
So this three dollars per share goes right here in the D0 spot.
Okay.
Now we need the dividend growth rate and this one is important.
So if we switch over to the history of the genuine parts dividend, what we can see that
they've actually made this quite easy for us.
They have the same dividend for each of the four quarters in any given year.
They do it for four quarters.
Then they increase it.
So all we need to do now is to try to find the dividend growth rate.
I'm going to zoom in a bit just so we could see this a bit easier.
But if we look at 2018 over a 2019, well, we can see that they had an increase of about
five point nine percent increase in the year before.
That was about six point seven percent.
And before that, we saw an increase of about two point six percent.
So if we stop right there, well, maybe we can average these three numbers out.
And with that, we end up with an average growth rate of slightly more than 5 percent.
So how about we round this one down a bit?
Just to be a bit more conservative, more call it in even 5 percent.
Now, the reason I say that this is very important for us to watch is because we really don't
want a dividend growth rate to be too high.
Anything higher than, let's say 5 or 6 percent is really pushing it, in my opinion, because
what we're saying is that the dividend will continue to grow forever at whatever this
dividend growth rate is.
Okay.
So let's move on so we could see how this dividend calculation plays out.
So we take our 5 percent dividend growth rate.
That one is the same one as it is down here.
Now, don't forget, we plug in point 0 5 to represent the 5 percent, not the whole number
5.
Okay.
Next, we need our required rate of return.
Now, coming up with the required rate of return should be somehow tied to the risk of the
investment.
And at the end of this video, I'll give a quick way away.
You can figure out how to calculate that.
But for now, for me, I'm just going to use a required rate of return of 8 percent for
each of our two examples.
Now, one thing to keep in mind is that our required rate of return must be higher than
our dividend growth rate.
Otherwise, this formula doesn't work at all.
Okay.
So let's plug in our zero point zero eight that represents our 8 percent required rate
of return.
And when we do the top part of this calculation, well, we take our current dividend and we
grow it by 5 percent and we end up with three dollars and 15 cents.
Now, really, what this is saying is that three dollars and 15 cents is what we're expecting
in dividends over the next year, over the next twelve months.
We took our past twelve months.
We said we're going to grow by 5 percent.
That's what it will be over the next 12 months.
Okay.
Then we take our dividend.
We divide that by point zero 3, which is the 8 percent minus the 5 percent.
And that gives us a fair value of this stock of one hundred and five dollars, which is
by coincidence, right.
About where genuine parts is trading at this moment.
Now, personally, I'd like to see this stock dip a bit.
If we're gonna jump in that way, we could buy it at a discount to our calculation of
fair value.
But each of us have to decide on our own where we want to buy.
But we can say that's the fair value.
We do want to pay more than that.
Otherwise, we would be overpaying for this particular dividend stock.
But what happens when we apply this very same calculation to a company like Apple?
So over the past four quarters, Apple has paid out a dividend of about three dollars
and 4 cents per share.
But now when we switch over to their dividend history, well, their growth rate from twenty
eighteen to twenty nineteen, they posted a dividend growth rate of more than 10 percent
and it was 13 percent the year before that and it was about 10 percent the year before
that.
Well if we average those three numbers out, well now we get a dividend growth rate of
about 11 percent.
And like I mentioned before, this growth rate can't be higher than our required rate of
return.
Otherwise, we end up with the negative number.
The formula doesn't work.
Okay.
So let's imagine that instead of 11.
Which is insane.
No company can keep that up forever.
Let's say we think that they can keep up 5 percent.
Now, if we're going to use 5 percent to be ultra-conservative.
Well, that would give us a fair value of Apple stock of one hundred and six dollars per share.
Right now, Apple is trading at more than 250 dollars per share.
So maybe we say, OK.
5 percent is too low.
What if we try 6 percent?
Well, 6 percent makes our fair value jump all the way to one hundred sixty-one dollars
per share.
This is still way below the current stock price.
Now I bring this out because I want to point out, one, how sensitive these this formula
is to our inputs.
So we want to be very careful with just randomly changing numbers like that.
I'm doing it to illustrate, I wouldn't really do that.
But our question is now, is Apple stock way overpriced or is there something wrong with
our formula?
And really, I used Apple in this example because this is an example of where the dividend discount
formula does not work.
Apple has far too much growth in the company and they pay a relatively small amount of
dividends compared to their profits and compared to their revenue.
So for a company like Apple, I think it's far smarter to do a valuation method like
the discounted cash flow method that would work fairly well for them.
So where we can use this formula is with large, well-established companies with long dividend
histories, companies like Johnson and Johnson or 3M that pay out a large percentage of their
profits as dividends.
For that, this formula works much, much more effectively.
I've actually considered doing a video where I go through all of the companies in the dividend
aristocrats ETF and try to come up with a fair value using this method to see our dividend
stocks overvalued at this point.
If you would be interested in seeing that, please let me know in the comments below.
That would be an interesting sort of analysis to try to go through, at least from my perspective,
from a learning perspective.
I think it could be a cool thing to try and if you're curious about coming up with a more
reasonable required rate of return.
Well, for that we could use something called the capital asset pricing model or CAPM for
short.
And I actually did a whole animation video on the calculation of CAPM and it could be
quite effective for coming up with the cost of equity, which could work as our required
rate of return.
So that could be a good next video to watch.
If you're interested and if you could please hit the thumbs up, hit the subscribe button.
Any comments, questions, thoughts?
You have put them in the comments below.
Thank you for stick with me all the way to end of the video.
I hope you found this interesting.
Thanks.
And I'll see you in the next video.