CVS Health (CVS) operates one of the largest domestic retail pharmacy networks and is a leading phar...
Omnicom: A Lesson in Dividend Yield Theory
06/08/2018 5:00 am EST
I often use the term “economic internals” when writing about a stock, and that those metrics are derived from economic data as opposed to the accounting data reported by companies each quarter and are regurgitated by the financial media, explains dividend expert Kelley Wright, editor of Investment Quality Trends.
Typically, there is a disparity between economic data and accounting data, which confuses investors as they have been conditioned by Wall Street and the financial media to accept accounting data as sacrosanct.
Let’s take Omnicom Group (OMC) for example. OMC has offered historically repetitive good value when its dividend yield is 2.20% or greater. Based on the current cash dividend of $2.40, a 2.20% dividend yield is realized at a stock price of $109 per share.
For several months now however, OMC has been trading at a significantly lower per share price, which has boosted its dividend yield far above its historically repetitive area of high-yield. Accordingly, some have questioned the efficacy of the Dividend Yield Theory and have suggested identifying repetitive dividend yield patterns is no longer applicable to value identification.
As you might expect I have an entirely contrary opinion, but not without a reason, which is based on my experience. It is true that the advertising industry is undergoing a change as new technologies and platforms become available to advertisers.
Change, you may have noticed, is part and parcel of capitalism and is nothing new. Industries evolve with technological advances, and consumers demand for new products and services evolves as well.
Where I believe Wall Street makes a mistake is by projecting, guessing if you will, how this evolution will flow through to a company’s earnings prior to any evidence of change in a company’s actual earnings.
I also believe they fail to take into consideration that a company with a long-term track record for excellence may be forward looking and has anticipated the need to adjust for change or have the experience and wherewithal to adapt after the fact.
Once Wall Street goes all in on a consensus opinion, however, the end result is often a lower stock price. For the enlightened investor this is a tailor-made opportunity to profit and here is why. Economic earnings are vastly different than accounting earnings. Converting accounting earnings to economic earnings requires making adjustments to the income statement and balance sheet.
These adjustments are necessary to reverse the accounting distortions and can only be determined by reviewing the Footnotes and MD&A (Managements Discussion and Analysis of Financial Position and Results of Operations) within the quarterly reports.
Time and space prohibit a line by line discussion for the adjustments made to OMC, but suffice it to say that the economic book value for OMC is almost $99 per share. At a recent stock price of around $70 per share, Wall Street is pricing OMC as if its future profit expectations will be about 30% beneath its economic book value permanently.
In short, Wall Street is making a top-down guess about the future profit growth of OMC, which is completely out of line with what the company is actually producing.
This creates a disparity in the price of the stock to the economic value of the stock, which is a gift to the value investor who is all too happy to buy almost $99 of value per share for only $70 per share, not to mention the receipt of an extraordinarily high dividend yield to boot. Now let’s circle back to the Dividend Yield Theory.
We can observe that millions of investors who do not know each other have concluded through their buying habits over significant time periods that OMC offers historically repetitive good value when the dividend yield is 2.20% or greater.
As I wrote earlier, a 2.20% dividend yield based on the current cash dividend is about $109 per share, just slightly above OMC’s economic book value per share.
My point here is that by using the precepts of the Dividend Yield Theory, that a stock’s value lies in its dividend and dividend yield pattern, we find that its Undervalued, high yield area is very close to its economic book value.
So rather than going through the long exercise of converting accounting data to economic data to arrive at the economic book value of a stock, the work is basically done for you by observing the repetitive patterns of high and low dividend yield, which have been established over significant periods of time by millions of knowledgeable investors.
Related Articles on DIVIDEND
I love getting those alerts. The ones that come in via email saying something like: “Your acco...
If you’re relying on your portfolio for income, monthly dividends are a godsend, because manag...
Harry Domash is a long-standing expert on income investing; in his latest Dividend Detective, he hig...