Why Valuation Matters
It's not what you buy, it's what you pay
Day 22 | Portfolio $2,858.06
I’m pretty stocked about all the stocks in the portfolio. I hand-picked all 30 because they are high quality companies with growing dividends. My plan is to own them for a long time.
But…even the best companies can be overpriced at times.
As legendary investor, Howard Marks says,
“It’s not what you buy, it’s what you pay.”
Buying with a Margin of Safety
Let’s talk about buying stocks with a margin of safety—a simple concept that helps protect you from overpaying!
The good news is that you don’t need to be a finance expert to get it right. A margin of safety means buying stocks at a low enough price that you’re covered if things don’t go as planned.
Here are two simple ways to make sure you buy with a margin of safety.
1. Price to Earnings
The P/E ratio compares a company’s share price to its earnings. A high P/E might mean strong growth expectations (a very good thing), but it could also mean that the stock is overvalued (a not-so-good thing.) Knowing the difference isn’t easy.
It’s best to not look at price-to-earnings in isolation. Actually, P/E alone won’t tell you much.
I like to check the current P/E against the company’s historical averages. For example, if a company’s current P/E is lower than it’s 5-year average, it could signal that it's a good deal.
2. Dividend Yield Theory
This one’s pretty neat!
Dividend Yield Theory is all about how a company’s dividend yield tends to bounce back to its average over time.
In other words, the dividend yield of stable companies often revert to the mean. So we can look at where a companies dividend yield is compared to its historic average to get an idea of its value.
If a stock’s yield is higher than its average, it might be undervalued—meaning it’s a good deal! Conversely, if the yield is lower than its average, the stock might be overvalued, suggesting it’s not a good time to buy.
In short, dividend yield theory is a handy tool to help you assess whether a stock is priced fairly based on its dividend payments. It’s a little guide to spotting good deals in the stock market!
A Valuation Shortcut
Wouldn’t it be great if there was a tool you could use to quickly compare a company’s P/E ratio and dividend yield to it’s historic norm?
Well, I want to introduce you to Simply Safe Dividends, one of my favorite tools for evaluating dividend stocks.
Tools like Simply Safe Dividends provide value recommendations based on factors like P/E ratio and dividend yield theory.
Example: Nike's Valuation
Simply Safe Dividends is showing that Nike “may be undervalued.” (Which I happen to agree with.) The stock price is currently around $80 and they expect the price to be within $89 to $109.
Based on dividend yield theory, the stock is “undervalued” with a dividend yield sitting way above the 5-year average.
Likewise, the P/E ratio of 25.9 is “undervalued” because its below the 5-year average of 31.9.
Both metrics suggest the stock is a buy! And that’s exactly what I plan on doing.
Now it’s your turn!
By keeping an eye on these metrics, you can make more informed buying decisions and build a portfolio that stands the test of time.
Until next time, keep walking!
Jeremy ✌️