This is something every value investor tries to figure out. How much is a business worth?
I wanted to put together the analysis I do while investing long term. Long term investing is a totally different game. Companies that survive crashes are the ones that grow rapidly. This post only talks about how I see if I should be looking at buying a stock or not.
Calculating how much a business is worth is a very difficult task. There are some rules that can be applied to a lot of businesses and some that just don't line up. Like what works for coke will certainly not work for REIT like O. Moreover, the market has so much fun with value of businesses. Taking off billions of dollars and adding billions in days or sometimes hours. According to theory, market will always correct itself. But, it rarely does. I think its due to human emotion factor.
I use a 3 point rule to value a business. Or rather, my rules to decide if I want to go into long term for a business. There is more to it when I buy, but these are more of a filter.
Does the business pay dividends? I only invest long term in the businesses that pay dividends. I am a little conservative with long term investments. not that I don't look for share price appreciation. I just want to preserve capital and earn high yield from dividends as a long term growth strategy.
- P/E ratio : This gives me a sense of how much forward value I am putting into a business
- Growth rate: This is kind of indicative of how much a stock price will likely rise.
- EPS : How much money they make per share. This helps me evaluate what percent of earnings go into dividends. above 60% is concerning 75%, nope! higher the ratio, higher is the risk of company cutting dividends or not increasing them
- History of a consistent increase in dividends
I buy the shares that I feel confident and follow the above rules and then enroll in DRIP. DRIP is very important for long term investing in dividend stocks. It averages out the price, increases exposure, compounds the the investment quarterly at the rate of divident rate/4. That is sweet! For a 2.5% dividend yield compounded quarterly, it is equivalent to 9.8 percent effective after 5 years. Pretty darn sweet.
That is without considering dividend increase and share appreciation. If you pick companies that have increasing dividends and increasing stocks for decades like KO, T, DIS, JNJ, you are looking at potential winners for generating consistent income. Also no commission on the shares you acquire. That is an added bonus, along with price averaging. I see no harm in it. any long term investor should look at it. I will only invest my long term capital in dividend companies unless something like GOOG happens.