EP122: What is Quality Dividend Value Investing?

What is Quality Dividend Value Investing? In this episode I’ll discuss one of the most powerful ways to build long-term wealth.

You’ll learn what dividend investing really means, how value investing works, what makes a stock truly “high quality,” and how these three ideas come together into a proven strategy for growing your income and wealth over time.

If you want to invest with confidence, reduce your risk, and build a portfolio that pays you year after year, this episode is for you.

Speaker 1 (00:00):
What is quality dividend value investing? In this episode, I’ll discuss one of the most powerful ways to build long-term wealth. I’m Kanwal Sarai, and welcome to the Simply Investing Dividend Podcast. You’ll learn what dividend investing really means, how value investing works, what makes a stock truly high quality, and how these three ideas come together into a proven strategy for growing your income and wealth over time. If you want to invest with confidence, reduce your risk, and build a portfolio that pays you year after year, this episode is for you. In this episode, we’re going to cover the following four topics. What is dividend investing? What is value investing? What are quality stocks? And finally, what is quality dividend value investing? Let’s get started with our first topic, what is dividend investing? Dividend investing is an investment strategy focused on investments that pay regular dividends, and those investments can be stocks, mutual funds, index funds, or ETFs.

(01:25):
So basically, people that are dividend investors are investing in stocks that pay regular dividends. A dividend is simply the company sharing its profits with you, the shareholder. So in this example, if a company is paying a dividend of $1 per share, and you own a thousand shares in that company, 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. That dividend is deposited directly into your trading account as cash, so you can spend that money if you wish, or you can reinvest it into other stocks that pay dividends. Now, I know some of you might have some concerns about dividends. What happens if there’s a dividend cut? What happens to dividends that get eliminated completely, and also the fact that dividends are not guaranteed. So I cover your top three dividend concerns in episode number four.

(02:28):
So if you haven’t seen it, I highly recommend you go back and watch episode four. Now, in this example, up on the screen, you can see as of this recording, the annual dividend per share for three sample companies. So Apple, again, as of this recording, has an annual dividend of $1.4 cents per share. Nike has a dividend of $1.64 and Target is paying a dividend of $4.56. So for example, if you were to buy a hundred shares in Apple, then you would get, at the end of the year, $104 in dividends because the dividends are paid. They’re paid quarterly, but we’re looking at the annual dividend for the whole year. And if you were to buy 100 shares in Target, you would get $456 in dividends. Now, we just don’t want to look at the dividend in isolation. We also want to take a look at the share price.

(03:29):
So here you can see, as of this recording, the share price for Apple is $260 a share. Nike is $65 a share and Target is $106 a share. So now you can start seeing how much money you really need to invest in order to start collecting dividends or significant amount of dividends. So for example, if you wanted to buy a hundred shares in Apple, you would have to invest $26,000 in Apple to be able to get 100 shares. If you wanted to get 100 shares in Target, you would have to spend $10,600, and 100 shares in Nike would be an investment of $6,500.

(04:15):
So you must be thinking now, what is the return on your investment while you’re holding onto the shares? Because in addition to the dividend, the share price is going to go up and down, but we’re going to set that aside for now and we are just focusing on dividends in this first topic here. So then what is the return on your investment? So you can figure that out easily by taking a look at the dividend yield. The dividend yield is simply the annual dividend divided by the share price. And so if we take a simple example here, let’s say a company is paying a dividend of $1 per share, and the share price today happens to be $20. So if we take a look at the formula up on the screen, it’s going to be the dividend, $1 divided by the share price, which is 20, so one divided by 20, and we want to express that as a percentage, it’s 5%.

(05:12):
So what does that 5% really mean? So let’s say in this example, you wanted to invest $20,000 in this company. With $20,000, you can see the share price is $20. You’re going to be able to buy 1,000 shares. A thousand shares multiplied by the dividend, which is a $1 a dividend, $1 per share. You can see that you will earn $1,000 in dividends in this example, right? Per year.

(05:43):
A quicker way to do that is to take the dividend yield, which is 5%, and you can see 5% of $20,000, that’s your initial investment, also gives you the same number, which is $1,000 in dividends per year. So we get to the same dividend amount, right? So the dividend yield is a very quick way to figure out the return on your investment while you hold on to your shares. And remember, the dividend yield is based on your stock purchase price. So once you’ve bought the shares, you know what your dividend yield is. And then in the future, in the next day or week or month or year, the stock price can go up, stock price can go down, but as long as the company is paying the dividend and you still have the same number of shares, your dividend yield will remain the same. So now let’s take a look at our three examples of the same companies again, Apple, Nike, and Target.

(06:44):
And now we’re going to add another column to our table here, and we are going to show you the dividend yield. Remember, the dividend yield is the dividend divided by the share price. So for Apple, the dividend yield today as of this recording is 0.4%. Nike is 2.5% and target is 4.3%. So all things considered equal, would you rather invest in Apple or a Nike or in Target? And so if we’re just looking at the dividend yield, of course, Target looks like a much better investment. Why? Because you’re going to make 4.3% return on your investment, just holding onto those shares. With Apple, you would only make 0.4%. Now there’s a couple of other things to consider. Of course, Apple may have higher stock price appreciation, and so that would make up for the lower dividend, maybe. The share price might be too high, right?

(07:44):
We don’t know. We’re going to cover share price high and overvalue and undervalue in just a few minutes later on in this episode. So now, just to wrap this up here, remember, the dividend investing strategy for dividend investors is to invest in companies that pay dividends. So does that mean that you should go ahead right now and invest in any stock that pays a dividend? And the short answer is no. There’s a couple of more things that we need to look at. And one of them we just touched on, the stock price. Is the stock price too high? Is it too low? And that is our topic number two. What is value investing? And that’s where we focus on the stock price. So value investing is a strategy focused on buying stocks that seem cheap compared to their intrinsic value. Looking for market mispricing where companies trade below their fundamental value.

(08:49):
So how do you know when companies are trading at low prices? Because that’s what value investors do. They are out there looking for companies that are priced low. In other words, looking for companies that are undervalued today. So a stock today, anywhere in the world is either going to be overvalued, which means it’s priced high or it’s going to be undervalued, which means that it’s priced low. And you’ve all heard the phrase buy low and sell high. And the reason for that is that’s how you can maximize your profits, your capital gains. If you can buy a stock when it’s low and then sell it when it’s overvalued. You don’t want to buy a stock when it’s already priced high because the probability of the price going even higher is very low because you’ve already bought it when it’s overvalued. So we want to look for stocks, especially as value investors, they want to look for stocks that are priced low.

(09:50):
So how do you know when a stock is priced low and how do you know when it’s priced high? We’re going to take a look at that right now. So we’re going to go back to our simple example of dividend yield. Remember the formula, you can see it up on the screen. It’s the dividend divided by the share price. So in this example, we have $1 dividend divided by 20. We express that as a percentage is 5%. Now let’s say you did not buy the stock when it was $20 and you waited a few days, a few weeks, maybe a couple of months, and the stock price dropped to $15 a share. Now you can see the dividend is still the same. Stock prices go up and down all the time. So in this example, and we’re keeping the number simple, just so to illustrate our point.

(10:39):
So in this example, the stock price drops, the dividend now is 6.7%. Remember it was 5% before, now it’s 6.7. Let’s say you wait a little bit more and the stock price drops further and now the stock price is $10. You can see the yield, dividend yield is now 10%. And if the stock price drops even further, the dividend yield is now 20%. So what is happening to the dividend yield as the stock price continues to drop? And you can see this on the screen. As the stock price is dropping, my dividend yield goes up. Now, all things considered equal, is it better to buy this company when it’s priced at $20 a share or better to buy it when it’s $5 a share? So $5 is going to be a better option. Why? Look at the dividend yield. 20% return on your investment versus five.

(11:39):
Now again, I’ve kept the number simple. Companies don’t pay that high of a dividend, but we’re just trying to illustrate our point here, right? Even if we use different numbers for the share price, the approach is the same. As the stock price starts to drop, the dividend yield is going to go up. And so you’re going to make more money in dividends. Why? Because the stock price is lower, you’re going to be able to buy more shares. And remember, the dividends are paid based on the number of shares you own. So now the reverse is also true. As the stock price starts to creep back up again, the dividend yield is going to go down. So you can see here, stock prices go up and down all the time. And we’re just looking at an example here up on the screen. You can see the chart is going up and down.

(12:29):
What if I was to tell you that for this company, over the last 25 years, the average dividend yield has been 3%.

(12:40):
And the current dividend yield today is 5%. So we know that 5% is higher than the average of 3%. This is your buying area. Everything below the orange line. That’s when the stock is priced low because as the share price decreases, the dividend yield goes up. So any yield above 3% in this example is going to be your buying area and that is when you should consider investing in this company. Now what if … So let’s finish off the formula here. So therefore, if the current dividend yield is greater than the company’s average, in this case 25 year dividend yield, then the stock is undervalued and priced low. Now, what if I was to tell you that today the current dividend yield is 1%. So now you know that the 1% is less than the average yield of 3%, the stock price is high. Remember, as the stock price increases, the dividend yield goes down.

(13:46):
So anything above the orange line, the stock is now overvalued, and that’s where you may consider selling it if you have it. And if you don’t have it, just wait. You don’t want to buy a stock when it’s priced high. So the formula here is if the current dividend yield is less than or equal to the average dividend yield, then the stock is overvalued or priced high. So you can see both of the formulas up on the screen right now. What if a stock does not pay a dividend? Like we have Tesla, Amazon, lots of other stocks that don’t pay dividends. So in that example, for companies that don’t pay dividends, we take a look at the PE ratio. So if the PE ratio is less than the average PE ratio, then we consider the stock to be undervalued or priced low. If the PE ratio is greater than or equal to its average 20 year or 25 year PE ratio, then we consider the stock to be overvalued and priced high.

(14:48):
So you can quickly figure out if a stock is undervalued or overvalued in our simply investing web application, our research platform. You can see I’ve highlighted the column here. This column will tell you immediately if a stock is undervalued, priced low, or overvalued and priced high. So does this mean you should go out and invest in any stock today that’s priced low? The short answer is no, not yet. There’s a couple of more things we need to check, and that brings us to topic number three in our episode, what are quality stocks? So not all stocks are the same. Even companies in the same industry, the stocks will not be the same. There are a lot of different variables that you could look at, but we’re going to make it really simple here. So just want to let you know that not all stocks are the same.

(15:51):
There are quality stocks and then there are non-quality stocks. We want to stay away from stocks that are not of high quality. So what makes a stock a quality stock? So for this, we have an eight point quality test. So you can see all of the eight points up on the screen here, and we’re going to go through them fairly quickly, just give you a general overview of each of these eight points. If a company passes all these eight points, then you know you’re looking at a quality stock. So the first one is, does the company have a low cost competitive advantage? So a good example here is to use Warren Buffett’s example. He talks about, think of a corporation as a castle. Around the castle, there’s a moat. The wider the moat and the deeper the moat, the better it is at keeping competitors away.

(16:48):
So companies that have large moats have a low cost competitive advantage. An example would be Coca-Cola. They’ve been around for more than a hundred years. They operate in over a hundred countries. They have worldwide brand recognition. And for you to start a soft drink or a beverage company today to compete directly with Coca-Cola, you would have to spend billions and billions of dollars in marketing and advertising, and you still wouldn’t get to where they are today. So they have a low cost competitive advantage. Another example is McDonald’s. There’s only one company in the world that can give you a Big Mac, and that’s going to be McDonald’s, and people will cross the street if they want a Big Mac to go to McDonald’s and get it, versus a local burger shop that could be closer to them. So companies that have a low cost competitive advantage have a very large moat around them, and it keeps competitors away.

(17:47):
The second thing to look at is, is the company recession proof. So think about this. If there’s a chance you may lose your job or we are in the middle of a recession, are you going to go out and buy a brand new car? Of course not. You’re going to keep the one you have or you’re going to look for other ways to get around. Same thing. If there’s a recession, there’s a chance you may lose your job or you’ve lost your job. Are you going to go out on an expensive overseas trip somewhere? Probably not. But even if you lose your job, you still have to eat. You still have to brush your teeth. You still have to turn the lights on in your home. So we look for companies that are recession proof, and those are going to be more of higher quality companies versus companies that are not recession proof.

(18:36):
The next thing is to look at a history of profitability, and that is the earnings per share, the EPS. How much money has the company made? What’s their track record? So take a look at two companies up on the screen here. We have company A and company B. You can look at company A, this is the last 25 years history of earnings, and you can see that the blue line is a steady increase and the line is going up, up, up, up, and up. So here’s a company that has had growing earnings per share, and that’s really good. That’s what we want to look for. Company B, it’s completely random. Sometimes they make money, and then you see there’s a number of years where the earnings are negative. Negative earnings means the company lost money. So the company makes money, then they lose money, then they lose some more money, then they make a little bit, and then they lose it again.

(19:29):
It’s completely random. When I look at the chart for company B, I have no confidence as to what’s going to happen next year. Are they going to make money or are they going to lose money? When I look at the graph for company A, I can have a high degree of confidence that this company most likely is going to have positive earnings and growing earnings next year as well. So looking at the history can give us some level of confidence as to what could happen in the future. So we want to look for companies that are profitable. Next, we want to look at dividend growth, because if we’re collecting the dividend, it would be nice if the dividend goes up every year because that’s more money in our pocket. Now you can see on the screen, again, we’re looking at company A and company B, the 25 year dividend history.

(20:20):
So company A has a steady increase in dividends year after year after year. And you can see that is a nice graph and that’s what we like to see. Whereas company B, they pay a dividend, then they lower the dividend, then they pay another dividend, then they cut the dividend completely eliminated, then they’ll pay a dividend again, eliminate it again. It’s completely random. I have no confidence when I look at the graph for company B, whether or not the company’s going to pay a dividend next year. With company A, I have some degree of confidence that they’re going to pay a dividend next year and hopefully it’ll be more than what they’re paying now. Next, can the company afford to pay a dividend? So here we look at the payout ratio. So let’s take a look at company A and company B. So you can see that company A, both of them have had the same earnings per share.

(21:14):
The EPS, it’s $2 per share. However, company A is paying a dividend of $1 per share. So the company earned $2 per share and they’re taking out $1 to pay the shareholders as a dividend, and the remaining $1 is kept in the company, reinvested back into the company to grow the business. So here they’re paying 50% of what they earned as a dividend to the shareholders. So this is good. It’s a healthy payout ratio. It means that next year they can pay a little bit more. The dividend could be like a dollar or five cents, a dollar 10 cents. So the dividend can go up a little bit. There is room for the dividend to grow. On the other hand, take a look at company B. They also earned $2 a share, but they turned around and paid the shareholders $3 per share. So that doesn’t make any sense.

(22:09):
Where did they come up with the money to pay the shareholders? They’re paying the shareholders more than what they earned. And so most likely they’re borrowing money from someplace else to be able to pay the dividend. And so this is not sustainable. The payout ratio is over 100%. The company’s either going to have to reduce their dividend or eliminate it or increase their earnings. And so that’s a risk that we don’t want to take. All things considered equal, company A is going to be a better investment. Now, is the next on the list is the debt. We take a look at the debt to equity ratio, long term debt to equity ratio. Is it less than 70%? And so company A, you can see the debt is 5%. Company B has a debt of 300%. And what happens when a company is carrying too much debt is in the event of a market downturn or a recession or interest rates go up.

(23:07):
A company that is carrying too much debt is going to have a very hard time paying down its loans or even making interest payments, right? So company B is going to have a hard time surviving a market downturn or a recession. Whereas company A is carrying very little debt and there’s companies out there that have debt of 0%, so that’s even better. So again, all things considered equal, company A is going to be a better investment. It’s going to be a higher quality company. Next, we want to avoid companies with recent dividend cuts. So that’s self-explanatory, right? If you see that the dividend today is a dollar, but last year was $1.50. Well, why did they cut the dividend? Why did the company reduce that? Are there earnings going down? Are the sales going down? Did they have massive layoffs? Did something negative happen there for them to reduce the dividend, or some cases companies will eliminate a dividend.

(24:11):
So we don’t want to take that risk. There could be hundreds of reasons why they cut the dividend. We just don’t want to take that risk, and so we would skip any company that had recently cut its dividend. And the next last one in our eight point test here is, does the company buy back its own shares? Now, again, I’ve kept the numbers very simple, round them off, very simple to highlight the point of share buybacks. So if we take a look at company A, last year they had three billion shares outstanding, and today this year they have 2.5 billion shares outstanding. So you can see they have much less shares today than they did last year. About half a billion shares have been removed, repurchased by the company, and so removed from the market. And so when that happens, generally, right, we’re speaking generally it’s a good thing for shareholders, right?

(25:12):
You’re reducing the number of shares outstanding and just based on supply and demand, the share price is going to start to creep up because there’s less shares out there, right? So that’s good for shareholders. Price is going to go up. Company B on the other hand had three billion shares outstanding last year, now they have five billion shares. So they’ve issued more stock. And again, because of supply and demand, if there’s more shares out there, stock prices are going to start to come down. So there you have it. Those are our eight point quality test. And if a company passes all of them, the company is then considered a quality stock. So there you have it. So what is a quality stock? It should pass those eight points that we just covered in our presentation. So does that mean that you should go out today and invest in any stock that’s a quality stock at any price?

(26:15):
And the short answer is no. There’s a couple of more things, and we’re going to wrap that up in our last and final topic in this episode.

(26:26):
What is quality dividend value investing? So a quick recap. Dividend investing is investing in stocks that pay dividends, and that’s what dividend investors do. Value investors are looking for stocks that are priced low. Quality stocks are stocks that pass our eight point quality test. And so therefore, you can probably figure this out. Quality dividend value investing is the best of all three of these attributes combined. So we are looking for dividend stocks that pay dividends, right? We are looking for stocks that are priced low and we’re looking for stocks that are of high quality. So if we wrap all that up into one sentence, our approach is investing in quality dividend paying stocks when they are priced low. And this is going to help you build a resilient portfolio regardless of what happens in the stock market that’s going to provide you with growing dividend income each year.

(27:34):
Now we don’t have time in today’s episode to go over some real life examples, but if you’re interested, I recommend you go back and watch episode number seven, where I show you some extraordinary returns with dividend investing. So how do you build a resilient portfolio? How do you go about that? And I’ve created what I call the 12 rules of simply investing. These are designed to lower your risk, save you time, and help you earn more. You can see the 12 rules are up on the screen right now, and we’ve already covered in today’s episode, rules number three, all the way to rule number 10. That was our eight point quality test, right? So those are all covered in there. I’m just going to talk about some of the rules that we didn’t cover in today’s episode. So the way this works is a company should pass all of the 12 rules before you invest in it.

(28:35):
If a company fails even one rule, skip it, move on to something else. And so rule number one is, do you understand how the company is making money? Rule number two, 20 years from now, will people still need its product and services? And then we’ve covered rule number three to 10 already. And then rule number 11, is the stock priced low? That’s where we’re going to compare the current yield to the average dividend yield. And then rule number 12, keep your emotions out of investing. So we have an all- in-one solution. We have a simply investing web application, that’s our online stock research platform, and we have our simply investing dividend course. The web app, we’ve got a screenshot here, is going to help save you lots of time. You’re going to be able to quickly see which companies to avoid because they’re overvalued and they fail our rules, and you’re going to be able to see which companies you should consider investing in.

(29:35):
So the web application makes it really simple, and we track all of the stocks in Canada and the US and apply the simply investing criteria to all of those stocks every single day. Our simply investing course, it’s an online course. Module one, we cover the investing basics. Module two, we cover the 12 rules of simply investing in detail. Module three, I’m going to show Show you how to apply the 12 rules to any stock anywhere in the world. Module four, we show you how to use the simply investing web application. Module five, how to place your first stock order step by step. Module six, building and tracking your portfolio. Module seven, when to sell. Module eight, how to reduce your fees and risk, especially if you own mutual funds, index funds and ETFs. Module nine, your action plan to get started right away. And module 10, I answer your most frequently asked questions.

(30:34):
If you’re interested in our all- in-one solution, be sure to write down the coupon code, save 10 S-A-V-E-1-0. It’s going to save you 10% off of our either monthly subscription or annual subscription, which gives you access to both the course and our web application. If you enjoy 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.