The following is a guest post by Saj Karsan. Saj regularly writes for Barel Karsan, a site dedicated to finding and discussing current value investments.
Stocks with higher dividend yields do outperform the market. Having said that, however, it’s important to be able to determine if a company’s dividend yield is sustainable.
Consider World Wrestling Entertainment (NYSE: WWE). CEO Vince McMahon’s antics are well known, both in the boardroom and as an entertainer himself! For those unfamiliar with his antics (or those who enjoy re-living WWE moments), a video example of McMahon in action is portrayed below:
WWE pays a dividend yield above 10%. However, the following chart demonstrates why you can’t choose a stock on dividend yield alone:
Clearly, WWE has been paying out more than it has been earning! Over the last four fiscal years (“2006 T” representing an 8-month transition year to a new fiscal year-end), WWE has paid out $1.06 more per share than it has earned!
How does it do it? Balance Sheet strength! The company has virtually no debt, and more than $2.80 of cash (including short-term investments) per share. That means it could continue to pay out cash over and above its net income by 25 cents per share for the next 10 years!
Does that make it a buy? Not quite. At a share price of $14, even if management immediately paid out that entire $2.80 to shareholders, one would still be paying $11.20 for a company that earned 62 cents / share last year, representing a P/E of 18.
When a dividend yield looks appealing, make sure it’s not too good to be true!