Join        Login             Stock Quote

Look Beyond P/E Ratios Dividend Investors

 January 30, 2013 10:25 AM

One of the typical valuation tools used by investors is the price earnings ratio. Price earnings ratio is calculated by dividing stock price over earnings.

Just as there are different investors, there are many ways that this otherwise seemingly simple indicator is calculated. Price is usually easily accessible in our information age, and it is typically the easiest input to be obtained online. Earnings per share is an indicator which often requires a little bit of additional research before applying in the equation. One of the first questions that investors need to ask themselves before looking at P/E ratios is to gain an understanding of the denominator in the equation.

I typically focus on earnings from continuing operations. I tend to exclude one-time accounting items such as goodwill impairment charges for example. The reason is that I focus on earnings stream that the company will generate from recurring operations. The fact that the company overpaid for a subsidiary five years ago is irrelevant for my investing decision, as long as this does not affect earnings from continuing operation. As a result, by normalizing earnings per share (EPS), I sometimes arrive at different P/E ratio figures than what you might usually see on Yahoo! Finance for example. Johnson & Johnson (JNJ) is a great case in point. While Yahoo Finance shows EPS of $3.86, my analysis calculated EPS to be $4.89/share.

[Related -Intel Corporation (INTC) and 5 Other Stocks That Could Pop on Earnings This Week]

[Related -Intel Corporation (INTC): An 18.1% Yield From Intel?]

Another question that investors should ask themselves is whether earnings per share are sustainable. I usually prefer to focus on companies that have the potential to grow earnings over time. A company with low P/E ratio could look undervalued. If analysts expect EPS to drop 50% however, and remain low, then it could end up being a value trap for investors. Apple (AAPL) currently trades at ten times earnings. However, this reflects the overall bearishness on the company's ability to maintain profits going forward, given the intensely competitive nature of the smartphone market. Sales of smartphones have accounted for a large part of Apple's growth over the past five years. Competition from Samsung, LG, and HTC has eroded Apple's market share.

If earnings per share are not steadily increasing over time, this could mean stock prices and dividends per share cannot sustainably grow. Investors should be advised to avoid such enterprises, as their dividend income is likely to remain stagnant. They would be much better off in fixed income, since they have a better chance of recovering principal.

One case in point is Intel Corporation (INTC). Over the past five years this tech juggernaut has suffered from low EPS growth. This has been caused by slowing sales in traditional computing devices. The company needs to expand presence in mobile devices chips. Thus shares appear undervalued, but without growth in earnings, investors returns are limited to the current yield. If earnings per share decline, the dividend payout ratio might become unsustainably high, and dividends might be cut. Either way, without earnings growth, future dividend growth will be limited. In addition, if Intel decides to spend more in R&D or buy its way in the market for mobile device chips, management might even decide to sacrifice the high dividend payments.

Full Disclosure: Long JNJ

iOnTheMarket Premium


Post Comment -- Login is required to post message
Alert for new comments:
Your email:
Your Website:

rss feed

Latest Stories

article imageXerox Corp. (XRX): An Insider’s $500,000 Insider Buy

Last week was a healthy week of insider buying as 194 companies reported purchase records. The number read on...

article imageQihoo 360 Technology Co Ltd. (QIHU) Q2 Earnings Preview: A Green Monday

Qihoo 360 Technology Co Ltd. (NYSE:QIHU) will report its second quarter 2014 financial results on Monday, read on...

article imageSix Stocks that Could Outperform in the next 90 days

Earlier today, Goldman Sachs put out its list of the 50 stocks that Matter Most. It’s a list of the 50 read on...

article imageFoot Locker, Inc. (FL) Q2 Earnings Preview: Running Past the Street View

Foot Locker, Inc. (NYSE:FL) plans to report financial results for its second quarter ended August 2, 2014 read on...

Popular Articles

Daily Sector Scan
Partner Center

Fundamental data is provided by Zacks Investment Research, and Commentary, news and Press Releases provided by YellowBrix and Quotemedia.
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. iStockAnalyst.com is not an investment adviser and does not provide, endorse or review any information or data contained herein.
The blog articles are opinions by respective blogger. By using this site you are agreeing to terms and conditions posted on respective bloggers' website.
The postings/comments on the site may or may not be from reliable sources. Neither iStockAnalyst nor any of its independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. You are solely responsible for the investment decisions made by you and the consequences resulting therefrom. By accessing the iStockAnalyst.com site, you agree not to redistribute the information found therein.
The sector scan is based on 15-30 minutes delayed data. The Pattern scan is based on EOD data.