MARKET COMMENT
Using Dividends To Find Cheap Shares

By Stuart Watson (TMFTiger)
November 27, 2002

There are many ways to value a company. However, one of the best is also, thankfully, one of the simplest. It is the dividend yield, the proportion of the current share price paid out each year in dividends.

Dividends are fact. There can be no disputing that a particular company paid out a dividend of, say, 20p last year, or that its dividends have grown steadily over the previous five years from 10p. If its share price is currently 400p then its dividend yield is 5%. With the average FTSE 100 company paying out a dividend of around 3.4% and risk-free government debt paying around 4.5% we can say that our prospective investment looks like a tasty morsel indeed. Easy peasy!

Well, not quite -- although it is an excellent place to start and it quickly gives you a shortlist of candidates on which to do further research.

In order to identify promising shares, you also need to assess the prospects for the company's dividends going forward. A history of steady or, better still, increasing dividends in previous periods of tough industry conditions can be a good indicator of how robust a company will be in future.

Of course this rules out many companies that haven't been around that long, either because they operate in new industries or they only joined the stock market relatively recently. Narrowing down your investment possibilities this way can put off many investors but, if the company is that great a prospect, there will have to be a time when it can be selected using dividend criteria too!

This sort of methodology is the approach behind our new premium product called "Shares To Make You Money". We've recently released the second report in this series, which concentrates on shares with attractive dividend yields in the retailing sector. The first report, published two months ago, looked at the banking sector and is still available. 

More: Valuing Shares | All About Dividends | Shares To Make You Money