Investing

Do You Know When To Buy?

By Kanwal Sarai
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investing_questionsEveryone has heard the phrase “buy low and sell high”. But how do you know when a stock is priced low? In this blog post I show you exactly how to determine if a stock is priced low. But first you'll need to know these two terms: dividend, and dividend yield.

 

Dividend

A dividend is a cash payment made to shareholders. For example the current annual dividend for Johnson & Johnson (JNJ) is $2.44. So if you own 100 shares in JNJ you will receive $244 each year for as long as you own those shares, and as long as JNJ continues to pay out a dividend. The dividend is yours to keep; you can spend the money or re-invest it if you wish!

 

Dividend Yield

The dividend yield is the annual dividend divided by the current share price:

Dividend Yield = Annual Dividend / Current Share Price

Using JNJ as an example, we can simply calculate the dividend yield:

Dividend Yield = Annual Dividend / Current Share Price

Dividend Yield = $2.44 / $69.86

Dividend Yield = 0.0349 * 100

Dividend Yield = 3.49%

3.49% represents the return on your investment. If you invested $8000 in JNJ you would receive $279 in dividends each year:

3.49% of $8000 = $279

 

Yield Goes Up

What happens to the dividend yield when the stock price goes down? Let take a look, suppose JNJ’s stocks price drops to $50, $45, or even $30:

$2.44 / $50 = 4.9%

$2.44 / $45 = 5.4%

$2.44 / $30 = 8.1%

Notice that the when the stock price drops the dividend yield goes up. You want to buy low because the yield will be higher which means a higher return on your investment.

 

When is a Stock Low

The best method for determining when a stock is low is to compare the stock’s current dividend to its average (10yrs) dividend yield. When its current dividend yield is higher than its average dividend yield the stock is undervalued (priced low) and worth consideration. It shocks me to see investors and fund managers not apply this simple principle and continue to buy stocks when they are priced high, and then they blame the stock market for their portfolio’s poor performance.

Remember there are other things to consider before making a stock purchase. In my course I cover the 12 Rules of Simply Investing, the check for undervalue is just one of the 12 rules, but it the most important one. If a stock is not undervalued you should move on and not spend any more time in valuating it further.

Buy quality stocks when they are undervalued and you will become a successful investor.

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Kanwal Sarai

With more than 27 years of investing experience and a passion for investing and teaching, I demystify the world of investing. My goal is to help you grow your net worth by investing in quality dividend paying stocks. Build your own stream of increasing income today.

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Showing 17 comments
  • Brett @ wstreetstocks
    Reply

    Your method is a great way to tell when a stock is low. Personally I use metrics such as the PEG and P/S ratios to decide when to buy. PEG and P/S ratios obviously don't take dividend yield into consideration, so that is somewhat of a downside.

  • Integrator
    Reply

    I use this method also. It is a pretty quick and effective way of assessing if something is above or below historical yield and therefore under or overvalued to your point. The one caveat is if there has been a deterioration in either the growth or performance of the business, investors may price the stock on a higher yield if growth prospects are no longer viewed as strongly, so being aware of business changes and possible repricing is important.

  • Matthew
    Reply

    This is a very concise and important subject. I haven't read this easy way to determine if a stock is low on any blog before. Thank you for that! It definitely makes sense.

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