Dividends, part II

I apologize to those of you who were expecting part II of the dividends post on Friday and it was not forthcoming. I ended up not having Internet access on Friday. So without further adieu…part deux.

So now you know that dividends are definitively a good thing, yes? That begs the question, “How do you find companies that pay reliable dividends?” The first step is to become familiar with the term “dividend yield.” Dividend yield refers to the amount of cash paid to you as an investor per share of stock that you own. This could be either common stock or preferred stock. The number is calculated as: dividends paid per share / price per share = dividend yield. Because the price of a share of stock changes every trading day then the dividend yield will also change every day. Does this make sense? Dividend yield is sometimes simply shortened to the term “yield.” You can find this information in most newspapers that carry financial information, as well as on most financial websites, such as Yahoo! Finance (I am not affiliated with them). Yahoo! Finance has a nice function that allows you to do a computer-based screening of all of the stocks in its database. That screening function allows you to find stocks that pay dividends as well as to sort the companies based on dividend yield. So wouldn’t you want to invest in the companies that pay the highest dividend yield? Isn’t a 13% dividend yield better than a 3% dividend yield? Well the answer is, as always: it depends. Depends on what?

High dividend yields can simply be the result of the math that drives the calculation: dividends paid per share / price per share = dividend yield. If the dividends paid per share remain fixed, while the price per share has decreased then the yield will increase. Confused? An example should serve to illustrate. Say that the price per share is $50 and the dividend per share is $2.50, that would mean a yield of 5%. This is calculated as $2.50 / $50.00 = 5.0%. Now what happens if the price per share falls in HALF!!! to $25/share? Then the yield increases to 10.0%, or $2.50 / $25.00 = 10%. Now imagine if you are using some sort of blind screen, like you just opened the financial pages of the newspaper and looked for big yields, then you would be more attracted to the company with the 10% yield than the 5%, right? But hopefully you can immediately see the error in this thinking as the appropriate question is: “Why did the price of the stock fall by 50%?” Usually such declines are for good reason and are reflective of the deterioration of a company’s fundamentals. So the real question to ask yourself is…

“What is the quality of the dividend being paid to me by a business?” Another way of thinking about this is: “Am I going to get paid?” In order to answer this question you need to make an assessment of the business’s fundamentals, with particular attention paid to the company’s cash flow statement. Don’t get scared now, I will walk you through this stuff carefully, slowly, and well. To find the company’s cash flow statement I recommend you go to the main source of all kinds of financial information: www.sec.gov/edgar/searchedgar/companysearch.html. This is one of the most amazing resources for investors in the world and it’s free! This is the Securities and Exchange Commission’s public website that allows you to pull up any publicly traded company’s financial statements. In the particular instance that we are going to be considering, the document in question is a Company’s 10-K. The 10-K is a firm’s annual report and it contains the financial statements, as well as tons and tons of other relevant investment information.

To make things easier we are going to be using a sample company that you can walk through with me, namely General Electric, whose ticker symbol is GE.

Easy steps to follow:

Step 1: In a separate browser window go to the above link that I gave you. A main search page is going to come up that has lots of fields for you to fill in.

Step 2: In the second box, entitled “CIK or Ticker Symbol” enter the ticker for General Electric, GE, and then hit enter. That brings up a massive list of all of the financial documents of General Electric. However, we are not interested in this massive list, we just want the 10Ks.

Step 3: So notice that on the right hand side there is a field entitled, “Form Type”? In that field type, “10-K” and then hit enter. That will bring up a new list of GE’s annual reports. At the time of this blog-posting the most recent 10-K was filed with the SEC on February 20, 2008, or in SEC EDGAR speak “2008-02-20.”

Step 4: Now I want you to click on the “[html]” link under the column heading “Formats.” This will bring up another screen that lists the major sections of the 10-K.

Step 5: Now I want you to click on the link “frm10K.htm“. That will take you elsewhere.

Let’s take a breather. I know that some of you get intimidated by this stuff. However, at this point just know that I am, in an anal retentive fashion, describing the exact steps that you need to take to access the information so that you can get rid of your broker, or second guess her, and make good decisions about dividends on your own. If I were pointing you to a recipe for fruitcake on the web the above instructions would also look and feel like the paragraph above. So….whew!…take a deep breath. Let’s continue.

After you click on “frm10K.htm” that will finally take you to the vaunted annual report. Thus far, all we have done is to navigate the SEC’s website. But now we have in our hands the most important financial document in the UNIVERSE! [cue dramatic music] Now that we are here, what are we looking for? Well let me share with you a little secret…financial statements are located in the exact same place in every company’s 10-K [drum roll please…]…Item 8. Yes, that’s right, the big secret is “Item 8”.

Step 6: So scroll down in the 10-K until you find Item 8. When you do that, on page 21 of the 10-K, you will come across something that says, “Item 8. Financial Statements and Supplementary Data.” Did you find it? Under that heading it says, “See index under item 15.” This is a very common thing for companies to do. Namely, they will point you to where the financial statements are located. Sometimes it is within the 10-K, as it is in GE’s case, or sometimes you get pointed to another document. Because of the minimal hassle of locating this information, even many professional investors do not search for this information! This means that by going through these simple steps, you will already be doing something that most people do not do, and therefore you have given yourself a strong competitive advantage and likely made or saved yourself some money. This is exciting stuff.

Step 7: So now scroll yourself down to Item 15. You will come upon it and described as, “Item 15. Exhibits, Financial Statement Schedules.” Did you find it? Excellent!

Now don’t be mad at me, but we are going to adjourn for the day and I will be back tomorrow. What can you do in the meantime? Empower yourself by practicing the steps I outlined above. Go find the 10-K for another company that you might be interested in, besides General Electric.

I shall return!

Jason