How we research a company before investing
Two companies can have the same dividend yield for different reasons. We explain how valuation and fundamental research help us decide whether a company fits an equity strategy.
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Research
Start with the price
Two companies can offer the same dividend yield for very different reasons. One may have raised its dividend as cash flow grew. The other may be trading at a lower price because investors doubt it can maintain the payout. The same number can point to two very different businesses. Before we invest, we want to know which one we’re looking at.
In the equity strategies that use them, we look at two measures. Relative Dividend Yield compares a company’s dividend yield with the broader market’s and considers how that relationship has changed over time. Relative Price-to-Sales Ratio compares what investors pay for each dollar of a company’s sales with what they pay for a dollar of sales in the broader market.
Examine the business behind the valuation
What keeps customers coming back? Where can the company grow? Has management delivered on the plans it laid out? The answers help us decide which numbers deserve a closer look.
Our 12 Fundamental Factor research process brings those questions together with measures such as revenue growth, operating margins, cash flow and debt. If the investment case rests on a company’s ability to charge more for its products, for example, we look for evidence in its margins and consider how customers have responded. If the dividend is central to the case, we ask how much cash the business generates and what other demands it has on that cash.
We use the same framework across companies, but the weight we give each factor depends on what has to go right for the investment case to hold.
The same yield, two different businesses
Return to the two companies with the same dividend yield. In this hypothetical example, the first has grown its cash flow while keeping debt steady. The second is generating less cash and has debt coming due. Both are still paying their dividends, but the second has less room to sustain its payout if business conditions worsen.
That distinction matters when we’re evaluating a company for a dividend growth strategy.
Where would the company fit?
A company can make a strong case for investment and still be a poor fit for a particular strategy. In a strategy focused on growing dividend income, we ask what could support future increases in the payout. In a strategy focused on capital appreciation, we may give more weight to what could drive earnings growth and how much of that growth the share price already reflects.
We also consider what the company would add to the portfolio. If several holdings already depend on demand from the same industry, for example, a new position could increase that exposure even if the company operates in a different sector.
That brings us back to the price. Before we invest, we want to understand what we’re paying for, what the business has to deliver and what role it would serve in the portfolio.
Laffer Tengler
Investment Team
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