Valuation indicators (4/9)

So is there a maximum yield to consider to avoid this kind of inconvenience? The answer is not that simple, but to do this we can use the distribution ratio. To maintain a margin of safety, a company should not pay more than 70% of its profit in the form of dividends. By doing so, it ensures that even if the profit falls, it will be able to maintain its distributions, or even increase them. A rate of 2/3 is often considered today as the norm, offering a good compromise between development opportunity and risk management. If we use the formula that says that the PER = distribution ratio / yield, we realize that if we take a stock that pays 5% of yield and we keep the limit of 70% mentioned above, we obtain a PER of 14. This means that if we buy a stock that offers a yield of 5%, the PER must be less than 14, to respect the balance. A PER of 14 is less than the historical average of the market and it is not common these days. In other words: from 5% of yield, beware. It is sometimes an opportunity and often a trap...

Conversely, is there a minimum to take into account? Until recently, I always considered that a yield of at least 2% was necessary to be worth it. However, over time, I have revised my position. I can very well accommodate stocks that pay significantly less, provided that the distribution ratio is very low (or that the PER is also very low) and that the company follows a policy of increasing dividends. If we use the formula distribution ratio = PER x yield, and we have a yield of 1% with a PER of 15, this gives us a distribution ratio of 15. Such a low level allows the company either to continue to invest in its own growth or to substantially increase its dividend in the future. In addition, the tax advantages of a low distribution policy are significant. I therefore do not set myself a minimum threshold in terms of yield, provided at least that a dividend must be paid, that it is increasing and that the distribution ratio is all the lower as the yield is low.

We have just reviewed the two most well-known valuation indicators, followed and used by investors. Both are certainly useful because they have the merit of comparing the price to a more or less concrete element. However, we have seen that both have several flaws and are only effective for large companies. Can we therefore find more effective ratios, in all circumstances? Fortunately, yes!