Below we take a look at three critical fundamental factors that a dividend investor should analyze apart from his or her regular dividend analysis. P/E ratio looks at stock valuation, business cycle analysis looks at market timing, and cash flow analysis looks at authenticity and confirms to us whether or businesses are cooking up financial statements.
As Walter Landor, the acclaimed pioneer of branding, puts it, “Products are made in the factory, but brands are created in the mind.” Many consumers will pay $100 for a T-Shirt with a recognizable logo, but would snub the same shirt sans logo at the same price sold at Generic Joes Local Shirt Shop. Stock markets work the same way, except as an investor you want to get in early. This means finding the company that produces T-Shirts (for example) of the same quality and has increased their payouts and earnings but does not yet have a brand, meaning that investors don’t value it as much as the Goliath in that industry. Such a company will have a lower stock price than said Goliath. Remember, a low P/E (stock price relative to earnings) is an investment, while high P/E is not. A quick search on Google Finance to identify whether your company has a lower P/E compared to other companies within the same market capitalization will help. Investors need good ‘value buys’ that offer an attractive dividend yield. Consider waiting until the P/E is attractive before making an entry.
Every industry is different and performs differently during different phases of the business cycle. Ever wondered why they say “If it rains in Brazil, buy Starbucks?” It means coffee bean prices stabilize when Brazil gets good rains and that increases Starbucks’ margins. Similarly, every industry has their unique fundamentals. For example, the auto and housing industries typically outperform during the early bull phase, capital goods outperforms during the middle bull phase, and the energy industry outperforms at the peak (this may not necessarily be the case in every bull-bear phase).There may also be thematic sector plays happening at any given time. Understanding where interest rates are, what kind of guidances companies are giving, and having a good idea about business cycles is an important part of any dividend investor’s decision-making process.
A dividend is actual cash that is distributed to investors. Looking at the cash flows in the cash flow statement and seeing a positive figure is one of the most authentic ways of proving that a company is not cooking up its financial statements. Some important questions to ask might be: How are cash flows from investments, operations and financing panning out? Is debt being repaid? Is new equity/debt being issued? Does the company have a bulletproof balance sheet? Does it have enough cash to buy XYZ? Is cash flow from operations showing an increasing/decreasing trend? Cash flows typically reveal accounting shenanigans and can reinforce one’s belief in the stock.
You Know Which Stock You Want to Buy, Now the Question is When Should You Buy?
Investors might cringe at the fact that we are recommending that our readers look at technical factors. Fundamentalists tend to find technical analysis blasphemy, and are not particular fans of it. Typically, reliance on technical analysis is good if you are a trader, but bad if you are an investor. However, we have picked out a few critical entry point indicators that, combined with fundamental analysis, can be pure gold.
Buy at the support price. A support price is the price at which a stock finds a lot of buying pressure. Technical analysis has an assumption that history repeats itself; so if a stock has bounced at a certain level in the past, then it will bounce at that level again in the future.
The chart below shows that Amazon experienced buying pressure at $60 about three to four times in September, once at the start of November, and three times at the end of January. If your analysis reveals that you should go for Amazon, then making an entry at $60 makes complete sense as it reduces risk.
Volume is the number of shares traded in any given period. Look for up days with higher volumes and down days with lower volumes. Combine this analysis with support/resistance and you are set.
In the above chart we see that at point A the up days were at very high volume, while the stock’s journey from A to B was at low volume. Its journey from B to C and D to E was again at high volumes. Here, history has repeated itself, thus there is a high possibility that it will repeat again. Combine this with the fact that the stock has support at around $2.50 and you have a convincing Buy.
My personal favourite. A gap is a range in the stock price where trading did not happen. In the above chart, we see that there was a certain range in the second week of January, 2006 during which trading did not take place (roughly from $66.20 to $67.20). The stock then directly opened ‘gap up’ at around $68. The general rule of thumb here is that all gaps get covered. Thus, we see that the stock fell down to the range where it opened gap up before proceeding with its journey upwards.
Similarly there are gap downs, which is when the stock moves up to the range where it did not trade. Gap downs are good entry points for your shortlisted stocks, while gap ups are not.
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The Bottom Line
A little bit of everything is always good for you. Broadening your perspective on key fundamental indicators as well as the technical analysis of key entry point indicators may help you get a better price for your stock.