Identifying Undervalued And Overvalued Stocks, Part 2

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Posted: May 15, 2018 10:00 AM
Identifying Undervalued And Overvalued Stocks, Part 2

There's an old method for assessing whether the price per share of an individual company that pays dividends to its shareholders that we've played with off and on since we resuscitated it back in January 2017. The method takes advantage of the relationship that exists between the amount of dividends per share that the company is expected to pay out to its shareholders over the next 12 months and the current day price per share of its stock, which if you track its trend over time, provides a means for telling whether the company's share price is either overvalued or undervalued at a given moment for its expected level of future dividends.

But it has a built-in weakness. In a stock market where many publicly-traded companies find it more advantageous to buy back shares of their own stocks rather than adjust their dividends per share, we can often run into the situation where the relationship between a company's dividends per share and its price per share shifts over time.

We directly ran into that analytical buzzsaw last November, when we applied the method to evaluate the state of the share price of General Electric (NYSE: GE). We found ourselves having to take GE's share buybacks into account in our analysis because the company's share price changed in response to its buybacks much more than did its projected dividend payouts.

We wondered if there was a way to take the changing number of shares out of the valuation picture. To that end, we hit on the idea of tracking the company's projected 12-month aggregate dividend payouts against its market capitalization, which theoretically eliminates the number of shares as a factor, but which are one step removed from the price per share and dividends per share data points that are much easier figures to come by. The following chart shows what we get track these measures for GE at the points of time when the company declared its future dividends from February 2010 through February 2018.

There's more noise in the relationship than we'd like to see, but it initially does appear effective in negating the effects of GE's share buybacks in the period between April 2015, when they started, and June 2017, before the company entered into its current period of financial turmoil, which may have indeed reset the level of the relationship between the company's market cap and its aggregate dividends.

GE should next declare its future dividend payouts in early June 2018. We'll check at that time to see how that relationship evolves, where we have other tools that we can apply to answer the question of whether there's a new relationship or if the old one still holds and we're just looking at the effects of pessimistic speculation on the part of investors.