EP121: What Are Deep Valued Stocks?

How do you know when a stock is priced low or high? How do you know when a stock is priced really really low?

In this episode, we break down what dividends are, how dividend yield works, and how to tell whether a stock price is truly low or just undervalued.

Learn what deep value stocks are, why they matter, and how they can help you earn greater dividend income, and more capital gains.

Speaker 1 (00:00):
How do you know when a stock is priced low or high? And how do you know when a stock is priced really, really low? In this episode, we break down what dividends are, how dividend yield works, and how to tell whether a stock price is truly low or just undervalued. Hi, I’m Kanwal Sarai and welcome to the Simply Investing Dividend Podcast. Learn what deep value stocks are, why they matter, and how they can help you earn greater dividend income and more capital gains. In today’s episode, we’re going to cover the following four topics. We’re going to start off with what are dividends? What is dividend yield? Is the stock priced low or high? And I’m going to show you exactly how to figure that out. And then the final topic, what are deep valued stocks and how do you find them? Let’s get started with our first topic, what are dividends?

(01:05):
Dividends are essentially the profits that a company shares with you, the shareholder. So in this example, if a company is giving a dividend of $1 per share and you own a thousand shares, you will receive $1,000 every year for as long as you own those shares and as long as the company continues to pay that dividend. Now, that money, the dividends, are deposited directly into your trading account as cash. So you can spend those dividends if you wish, or you can reinvest them. Now, some of you might have questions about dividends like what happens to the dividend when the stock price goes down? Are dividends guaranteed or not? So all of that is covered in episode number four. And if you haven’t watched it, I highly recommend you go back and watch episode number four, where we talk in detail more about dividends. Now let’s move on to our topic number two.

(02:01):
What is dividend yield? The dividend yield is simply the annual dividend divided by the share price. Let’s see what that looks like. We’ll put some simple numbers in here, make sure the math is really simple. So you can see it up on the screen here. In this example, the annual dividend that the company is paying is $1 per share. So you can see we have $1 up on the screen. The share price, let’s say today, happens to be $20 a share. So the annual dividend divided by the share price, that’s one divided by 20. And we express that as a percentage, it’s 5%. So what does that 5% really mean? So let’s say in this example, you want to invest $20,000 in this company and you know that the shares are trading at $20 a piece. You’re going to be able to buy 1,000 shares.

(02:54):
And we know that the dividend is $1 per share. So we take 1,000 shares, multiply by $1. You will earn, in this example, $1,000 in dividends each year. Now, as long as the dividend stays the same and as long as you continue to own those 1,000 shares. Another way to look at it, and this way is a lot faster, is we take the dividend yield, which in this example is 5%, and we know that we want to invest $20,000 in this company. So what’s 5% of $20,000? And you can see that up on the screen, the answer is $1,000, and that’s how much you would earn in dividends each year. So in both examples, we end up with a $1,000. And what that means, the dividend yield, it means that is the return on your investment while you hold on to your shares. Because after you’ve purchased those shares, in this example at $20 a share, if the stock price goes up or the stock price comes down, doesn’t matter.

(03:58):
Your dividend yield will remain at 5% because like I said before, it’s the annual dividend divided by the share price, or in this example, your purchase price. So the purchase price is not going to change in the future because you bought the shares today at that price. So the dividend yield remains the same. Now, the good thing is over time, with a lot of the companies that we follow, I’ve been a dividend investor for over 25 years. We are investing in companies that grow their dividend consistently. So we’ll take a quick example. Coca-Cola has had over 60 years of consecutive dividend increases. Procter & Gamble, I believe is more than 65 years of consecutive dividend increases. So in the future, when the company increases its dividend and you still own those shares, now you’re going to make more money in dividend income. So keep in mind, this is just repeating the last slide, but the slide here says your dividend yield is based on your stock purchase price.

(05:06):
So that just means the price can go down for those shares, the price can go up, but your dividend yield, and the example we just looked at would remain at 5%. Now let’s move on to topic number three. Is the stock price low or high? And I’m going to show you exactly how to figure that out for … You can do that with any stock anywhere in the world. So you’ve all heard the phrase buy low, sell high. Why would you want to do that? What’s the benefit of doing that? Well, I’ll give you an example. If a stock is priced low at $20 a share and you buy it at 20, and then it’s priced high at 50, you can buy it at $20 a share and then sell it for $50 a share. So that means increased capital gains for you. There’s no point in buying the shares at $50 if that is historically the high price.

(06:00):
If the shares are priced high, there’s no point in paying $50 for those shares or $51 or $49, because the likelihood of the shares going higher in the future is extremely low because you’re buying them when the shares are priced high. So you want to buy them when they’re low. So I mentioned the benefit already of increased capital gains. The other benefit is increased dividend income. Because if you buy the shares when they’re low, you’re paying a much lower price, you’re going to be able to buy more shares, right? If the shares are priced at $20 a share and you have $1,000 to invest in the company, you’re going to be able to buy more shares than if they were trading at $100 a share. And remember, like I said before, the dividends are paid based on the number of shares you own. So if you were able to buy more shares, because the share price was low, you are going to get more dividend income versus somebody who pays 80, $100 per share in that example.

(07:02):
So those are the two big benefits of buying low. So that’s what we’re going to cover in this topic is how do you figure out when a stock is undervalued, which means the stock is priced low. Historically, it’s low. And when is a stock overvalued, meaning that the share price is high, historically high. So we’re going to do that right now. So we’re going to go back to our example of the dividend yield. So you can see that up on the screen. I’m going to use the same numbers. The dividend divided by the share price is the dividend yield. So let’s say the dividend is $1 a share and the shares are today trading at $20 a piece. Your dividend yield would be 5%. Now, let’s say you didn’t buy the shares today and you waited a few days or a few weeks and the share price dropped to $15 a share.

(08:00):
Now look at my dividend yield. It used to be 5%. Now the dividend yield is 6.7. Why? Because the dividend is the same. The annual dividend per share has not changed. The stock price has gone down. So now we take the $1 dividend divided by $15 a share. You can see the yield is 6.7%. Now let’s say, and again, I’m keeping the numbers very simple so that the division is easy to figure out. Real life examples are a little bit different in terms of dividend yields. They range mostly at around three and a half percent, but let’s just stick with our example here. I’m trying to illustrate a point. So let’s say even at $15 a share, you don’t buy the shares, you wait a couple of weeks, couple of months, maybe a year, and the stock price drops even further to $10 a share.

(08:51):
Look at what is happening to my yield. Now it’s 10%. And let’s say you wait even more and the stock price drops to $5 a share and you can see on the screen the dividend divided by $5 a share and the dividend is $1. The yield now is 20%. Again, these are just examples. I’m just trying to illustrate a point here. The math works even if the dividend is much lower. But what you’re going to notice here is as the stock price continues to drop, what is happening to the dividend yield? You can see that the dividend yield starts to go up. We started at 5% dividend yield, and then we got 6.7%, then 10%, then 20%. So as the stock price gradually started to go down, the dividend yield started to go back up. Now the reverse is also true. If the stock price starts to creep back up again, the dividend yield is going to go down.

(09:54):
So this is very, very important. So I want you to pause the video here and maybe go back a couple of seconds where I’m going to repeat the same thing again. So pause the video here, take a look at the slide on the screen, and this is very important because everything else, the rest of the episode is based on this. So I’m going to repeat it one more time. As the stock price starts to go down, the dividend yield goes up and the reverse is true. If the stock price starts to creep back up again, the dividend yield is going to go down. And all things considered equal in this example, is it better to buy the shares when they’re at $20 a piece or is it better to buy them when they’re at $5 a piece? Again, all things considered equal, it’s better to buy them at $5 a piece.

(10:43):
Why? Look at the dividend yield. You’re going to make a 20% dividend yield return on your money versus 5%. Now again, this is for illustration purposes only. The math still works when the dividend is much lower. The average dividend yield across companies in the US and Canada is around 3.5% dividend yield. Okay. We’ve kept the math simple here, so it’s easy to kind of go through it very quickly on the screen. So now let’s see what that looks like in real life. Stock prices go up and down all the time. So let’s say we were looking at a company here, we’ll call it company ABC. And what if I was to tell you that over the last 20 years, the average dividend yield for this company has been 3%.

(11:34):
Okay? And then today the current dividend yield is 5%. So you can see that the current dividend yield is 5% is higher than the average 20 year dividend yield. And because the current yield is higher, then the stock price must be lower. Remember, as the stock price drops, the dividend yield goes up. And so this is your buying area. You can see it on the screen here. That’s the blue area. That’s below the orange line. And that is ideally when you would want to buy the shares because that is your buying area. Remember, as the share price decreases, the dividend yield goes up. So anytime the yield, in this example, anytime the dividend yield, the current yield is over 3%, you know that the stock price is somewhere below this orange line. And now you know when a stock is undervalued or priced low. And you can see the formula up on the screen.

(12:36):
It’s really simple. If the current dividend yield is greater than the 20 year average dividend yield, then we consider the stock to be undervalued and priced low. Now, what if today the current dividend yield was 1%? Well, then you know that as the dividend yield goes down, the share price is going to go up. And now the share price at the current dividend yield of 1%, the share price is above the orange line, and that’s when the stock is going to be overvalued, and that’s when you would want to sell it if you owned it, right? So you can see that the yield below 3% in this example is going to be anywhere over the orange line. And so the formula for figuring out when a stock is overvalued is the current dividend yield is less than or equal to the 20 year average event yield, then we consider the stock to be overvalued.

(13:36):
So if you don’t own those shares and you check the current yield and you compare it to the average and you figure out the stock is overvalued, then you know you can ignore the stock for now, it’s not worth investing in, and you would move on to something else. So here you go up on the screen, these are the two formulas that you need to know. If the current dividend yield is greater than the 20 year average divin yield, then the stock is priced low, undervalued. If the current dividend yield is less than or equal to the 20 year average driven yield, then the stock is considered to be overvalued or priced high. Now, what about companies that don’t pay dividends? There are companies out there that don’t do that. How would you figure out when those stocks are priced low or priced high? So I’m going to give you the formula here.

(14:27):
You can see it’s based on the PE ratio. So if the PE ratio is less than the average 20 year PE ratio, then we consider the stock to be undervalued. If the PE ratio is greater than or equal to the average 20 year PE ratio, then we consider the stock to be overvalued. So how do you figure this out? You can do the math yourself. It does take time. You’d have to go back and look at the 20 year average dividend yield, calculate the average. The dividend yield over the last 20 years, take the average, and then the current dividend yield you can get on any website that gives you stock quotes, and you could figure out if the current yield is higher than or less than its average 20 year dividend yield. If you don’t have access to 20 year data, maybe you can do it for 10 years, 15 years.

(15:15):
It’s still better than nothing. So that’s one way to do it. Another quicker way is we track all of the numbers and data for you in the simply investing web application, our platform. You can see a screenshot here. And so in the platform, you can immediately see which companies are undervalued and which ones are overvalued. Now, this is a screenshot that was taken a while ago, so please do not focus on the company names there. That list changes over time. So this was an older screenshot, but I just wanted to point out, and you can see highlighted in red. We do have a column there that will tell you if a stock is undervalued or overvalued, and we do that for all of the stocks trading in the US and in Canada. Now let’s move on to our last topic in this episode. What are deep valued stocks?

(16:14):
Deep valued stocks are shares of companies trading at extremely low historical prices. And I’ll get into that more in just a minute. What we don’t consider in this example, and there’s a lot of different ways of evaluating a stock, whether it’s low or high. And so some folks will use the PE ratio, and I showed you an example of that in a couple of slides back. If the PE ratio is less than the average 20 year PE ratio, then we consider the stock to be undervalued. If the current PE ratio is greater than or equal to the 20 year average PE ratio, then we consider the stock to be overvalued. So that’s one way to do it. Some people look at the price to book value, so they want to buy a stock that’s trading at book value or below book value because they consider the stock to be priced low.

(17:09):
So that’s another way to do it. Some people will look at the Graham price, that’s the Benjamin Graham’s formula, and they try and buy the stock at that price or lower than the gram price. And then some people will use the discounted cash flow to estimate fair value, and they want to see if they can get a stock for below fair value because they think the stock is priced low. So none of these evaluation methods are incorrect. Some people use more than one to figure it out. In the simply investing course, we use three of them. We look at the PE ratio, we look at the PB ratio, and then we look at the current yield and compare it to the 20-year average yield. So we look at all three of those, and there’s more than what you can see on the screen here. There’s lots of different ways of evaluating it.

(17:55):
Some people look at stock charts and they try and see, okay, when is the stock going down and try to figure it out from there, whether it’s worth buying or not. So we’re going to keep things simple here. In this topic, our last topic in this episode, we’re going to keep it super simple. And this is what I use, and that’s what we use in our web platform to define what is a deep valued stock. And I’ll show you that right now. Let’s take a look at two companies, company A and company B. You can see that the average 20 year dividend yield for both of the companies is 1.9%. And I put the formula down again on the screen at the bottom, just to remind you, if the current dividend yield is greater than the average 20 year dividend yield, then we know the stock is undervalued.

(18:47):
So is company A and B undervalued? Well, we don’t know yet. We need to take a look at the current dividend yield. So let’s say for company A, the current dividend yield is 2.2%. So we can see super simple, 2.2% is greater than 1.9. Company A is undervalued. Let’s take a look at company B. Current dividend yield is 5.8%. So company B is also undervalued. So now both of them are undervalued stocks. Now, all things considered equal, let’s assume company A and B are in the same industry. They have the same level of debt, they have the same level of dividend growth, earnings growth. All the numbers are the same, all things considered equal. Just the dividend is different. Would you rather invest in company A or company B? So company B is going to be a better investment. Y? Look at the dividend yield.

(19:48):
It’s 5.8%. Why not make 5.8% on your money versus 2.2? So company B would be a better investment, all things considered equal. What you’ll notice here is that company B is actually deep valued, and I’ll tell you why we label it that way. They’re both undervalued. So A is undervalued, so is B, but B is way undervalued. The stock price has gone down so much further that its dividend yield is much higher. And so remember this is the definition I showed you in the beginning. So this is our definition of deep value stocks. Other people have their own definition. So our definition is that these are shares of companies trading at extremely low historical prices. How do we figure that out? We look at the difference between their current dividend yield and the average 20 year dividend yield is equal to or greater than 200%.

(20:48):
So now let’s take a look. Company A, its current dividend yield is 16% higher than its average yield. Okay? Not bad. Company’s still undervalued, 16%. Company B has a difference of over 200%. So it’s 205 to be exact. Its current dividend yield is 205% greater. The difference between the current and the average yield is 205%. So again, you could figure this out. You’d have to calculate it yourself. You’d have to get access to historical data. We make it a lot easier. You can see in the screenshot right here in the simply investing platform, our web application. We have a dropdown and you can see I’ve highlighted in red. And from right there, you could say, give me a list of all of the dividend stocks that are deep valued. And in this example, we’re looking at the New York Stock Exchange and we cover a NASDAQ and the Toronto Stock Exchange as well.

(21:48):
So automatically with a click of a button, you can get a list of all of the stocks that are deep valued, which are sort of bottom basement prices. They’re on sale. The prices are so low. Now keep in mind, this is a screenshot. It’s an older screenshot from a while back. So don’t go by the numbers or the company names you see on the screen here because this data changes all the time. But nevertheless, it’s available to you right there and we make it a lot simple and we track every stock in the US and in Canada in our web app or the platform, the simply investing platform. So couple of benefits of buying a stock when it’s deep valued and it’s the same as what I showed you before. There’s potential for higher capital gains because not only are you buying the stock when it’s low, you’re buying it when it’s really, really, really low and the potential for higher dividends, right?

(22:46):
Because you’re going to be able to buy more shares because the stock price is low and you’re going to get more dividends as a result of that. Just a couple of guidelines and some risk that I want to share with you before we end this episode. Number one, I don’t recommend this for beginners. If you’re a beginner and you’re looking at a DIY do- it-yourself option for dividend investing, then I’m going to recommend you follow all of the 12 rules of simply investing. I’m going to cover those in like a couple of minutes, follow those and just go with that first and foremost. Okay? So it’s not for beginners, it’s people who already have investing for a number of years, are comfortable with taking a risk. And there is some additional risk here, right? Stock prices have fallen far below their fundamental worth, and that could be due to market sentiment, industry downturn, or a temporary company problem.

(23:44):
And so that’s why the stock might be cheap for a good reason. It could be poor management, a declining business, and the company might fail to ever recover from that. And we saw that with the GE. The general electric of today is not the same company it was 25 years ago. The company’s a lot smaller, they had massive layoffs, they cut a lot of their business products.

(24:09):
The company is a lot smaller. And so when the stock prices come down, of course, a company might become a deep valued stock, but you have to look at the reasons as to why is the stock price so low. Are there fundamental problems at the company? And you can look at the income statement, the balance sheet, go back five, 10, 15, 20 years, look at the records. Is the company performing poorly and are they on a downhill track? If they are, stay away from it. If they’re not, then there could be some opportunities there for investing into a deep valued stock. Now, often it takes years for the market to rerate these stocks, right? So this demands conviction and discipline. You got to stick with your … If you’ve done your homework, and I’m going to show you the 12 rules, if you follow the 12 rules, then as long as the dividends are coming in, as long as the dividends are growing, as long as the earnings are growing, then you can hold onto the stock.

(25:14):
It might take years for the stock price to come back up again because you bought it when it was not only low, but really, really, really low. So you have to understand that, right? So successful deep value investors look for quality companies that are temporarily down. So those are the good candidates. Those are the ones where they’re still a quality company, but they’re down for some other reason. Just because of market sentiment or someone said something online and the sector is down or the industry is down, so it drags all of the companies down, even the good ones. Those could be good buying opportunities. So that’s what you want to look for. And diversification is important, of course. First and foremost, you don’t want to put all your money into deep valued stocks. You want to diversify so that you can lower your risk. So does this mean that you should go out and buy any deep valued stock out there today?

(26:14):
And the short answer is no.

(26:18):
We help you build a resilient portfolio that provides you with growing dividend income each year, and that’s our approach, the simply investing approach. You want to invest in quality dividend paying companies when they are priced low. Even if they’re deep valued, we still want to make sure that they’re quality companies. So how do you know when you’re looking at a quality company and how do you know that it’s undervalued? Well, for that, I’ve created what I call the 12 rules of simply investing. The rules are designed to lower your risk, save you time, and help you earn more. And you can see the 12 rules up on the screen here, and the way it works is the company, especially for beginners, you want to make sure it passes all the 12 rules. If a company fails even one rule, skip it, move on to something else.

(27:07):
Now, even for deep valued stocks, ideally, if you can find a stock that’s really, really, really undervalued and it passes the 12 rules of simply investing, then you know you’ve got a quality company on your hands because you’ve looked at the profitability, the earnings, the dividend growth, all of that. So I’ll just quickly go through them. Rule number one, do you understand how the company is making money? If you don’t, skip it, move on to something else. Rule number two, 20 years from now, will people still need its product and services? Rule number three, does the company have a low cost competitive advantage? Rule number four, is it recession proof? Rule number five, is the company profitable? Rule number six, does it grow its dividend? Rule number seven, can it afford to pay the dividend? Rule number eight is the debt less than 70%. Rule number nine, avoid companies with recent dividend cuts.

(27:59):
Rule number 10, does it buy back its own shares? Rule number 11, is the stock priced low? And that’s where we look at the PE ratio, the PB ratio, and we compare the current yield to the average dividend yield. And rule number 12, keep your emotions out of investing. So we have an all- in-one solution. We have a simply investing dividend course and the simply investing web application or our platform. And the platform makes it a lot easier, saves you time, because it will apply the simply investing criteria to over 6,000 companies in the US and in Canada every single day. And so you can immediately see which companies are undervalued, which ones are overvalued, which ones you can skip, which ones you should focus on. The Simply Investing course, it’s a online course, 10 modules. It’s a video course. Module one covers the investing basics.

(28:58):
Module two covers the 12 rules of simply investing. Module three, learn how to apply the 12 rules to any stock anywhere in the world. Module four, using the simply investing web app. Module five, placing your first stock order, module six, building and tracking your portfolio, module seven, when to sell, which is just as important as know when to buy. Module eight, how to reduce your fees and risk, especially when it comes to mutual funds, index funds, and ETFs. Module nine, your action plan for getting started right away, and module 10, I answer your most frequently asked questions. If you’re interested, you may want to write down the coupon code, save 10. It’s S-A-V-E one zero. Save 10 is going to save you 10% off of our all- in-one solution, whether you go with a monthly subscription or an annual subscription, you can get 10% off, and that coupon code stays with you, and so as long as you remain an active subscriber, you continue to get that 10% discount.

(29:59):
If you enjoy to today’s episode, be sure to hit the subscribe button, hit the like button as well. And for more information, take a look at our website, simplyinvesting.com. Thanks for watching.