National Numeracy Network > NNN Columns > Dividend Yielding PE Ratios

# Dividend Yielding PE Ratios

This material is replicated on a number of sites as part of the SERC Pedagogic Service Project

Dr. Eric Gaze
Director of the QR Program
Bowdoin College

Numb: Corning Inc. has a PE ratio of 4.5.

Number: Corning Incorporated's share price is currently trading at 4.5 times its earnings per share, with a dividend per share of \$0.20.

Num-best: Corning Incorporated's share price is currently trading at 4.5 times its earnings per share, with a dividend per share of \$0.20 yielding 1.37% of the current price per share. This unbelievably low PE ratio is roughly one-fourth the historical average price-to-earnings ratio of the market.

The current financial crisis has certainly highlighted the financial illiteracy of much of our populace. I was surprised the first time I discussed stocks and bonds with my students, and discovered how little they knew about the fundamentals of investing. Given the inordinate amount of press dedicated to the Dow Jones Average and accompanying markets you would naively assume everyone in the country has at least a basic grasp of what the pundits are pundit-ting. Consider the following stock "quote":

This snapshot illustrates why numeracy is synonymous with quantitative literacy. James Gee defines literacy to be control of language in a secondary discourse. A discourse is a role we play, with our primary discourse being familial and all other roles – male, professor, parent, American, etc. – being secondary with their own language. In order to read a stock quote one must have control of the vocabulary and syntax used in financial discourse. A prerequisite for this control is having a well developed schema in our brains for what stocks are and how they are used. Only then can the last trade, volume, shares outstanding, etc. make any sense, and cause someone at their computer to exclaim: "I should have bought Citigroup when it dipped below \$1. I could have quadrupled my money and today alone made 17%!!!"

At this point it might help to paste in another statistical snapshot laden with discourse specific terminology. A fantasy baseball player is well versed in OBP, SLG, and OPS and can immediately tell from looking at these data that Kevin Youkilis is a fantasy stud who is going to cost a lot of money on draft day:

Fantasy baseball players are always on the lookout for value players in much the same way stock jocks are looking for value plays. Kevin Youkilis was such a value player 6 years ago when he was highlighted in Michael Lewis' excellent book, Moneyball: The Art of Winning an Unfair Game. This book revealed how the emerging science of data crunching was affecting baseball scouting, with Youkilis exemplifying a player overlooked by "expert" scouts but tapped by computer regression models as having tremendous potential.

So what should we look at to determine if a stock is a value play or is currently overpriced? The PE ratio is the most basic measure of a stock price's value. It simply compares the share price to the earnings per share. In the case of Citigroup above, we compare \$4.45 per share to -\$5.56 in earnings per share to get the PE ratio of -0.8x. The x denotes that a share of Citigroup is currently trading at -0.8 times the earnings per share, the -0.8 is really the ratio -0.8 : 1.

The earnings per share is a ratio itself, comparing total earnings (negative meaning the company lost money) to the number of shares outstanding. The share price is what people are currently willing to pay for one share of Citigroup stock. Many of my students think that the share price must necessarily be linked to the earnings per share in some concrete quantifiable way. The reality of course is much vaguer. In much the same way that the price someone pays for Youkilis on draft day varies with buyers' emotional attachments to his abilities, the price of a stock is in constant flux related to emotional assessments of its worth. A fantasy baseball player from Boston might load their team with Red Sox players in much the same way an employee of Citigroup might load their portfolio with Citigroup stock; with both suffering the consequences when their team/company has a bad year.

We use the PE ratio to help us avoid emotional attachments that cloud our judgment, instead providing an objective assessment of the stock's value. It is easy enough to say "Buy low; sell high!" but how can we tell if the share price actually is "low"? To answer this, the PE ratio provides context by comparing the share price, what we have to pay for it, to what the company actually earns. Next we need historical context in order to determine when the PE ratios are themselves low enough to trigger a buy order from us. The March 2009 Money Magazine claims the PE ratio's historical average is 16, meaning that, on average, people have been willing to pay 16 times more per share than the company earns per share. In 2007 the PE ratio was 28, and today it is around 14, a 50% reduction in 2 years.

Let's take a look at a company that is actually earning money, Corning Incorporated. On April 15, 2009 it was trading at \$14.70, 4.5 times its earnings per share of \$3.30! Hopefully you can now appreciate the exclamation point at the end of the last sentence. This company has a PE ratio of 4.5, well below the historical average of 16. General Electric by contrast was trading at \$11.83 per share, 6.9 times its earnings of \$1.72 per share. These phenomenally low PE ratios explain why the market rose 20% in the month of March. The market was completely oversold and buyers jumped in, causing the share prices to rise.

Another common measure of a stock's worth is its dividend yield, the ratio of its dividend per share to the price per share. A dividend is an amount of money the company pays to its shareholders, say \$1 per share. This is a literal "share the wealth" campaign. A big difference between buying a share of Citigroup stock versus buying Youkilis for your fantasy team, is that the share of stock makes you part owner of the company; and thus entitled to a piece of the profits. To put your ownership in perspective, the stock quote for Citigroup indicates that there are 5.5 billion shares outstanding, which multiplied by the \$4.48 per share, gives the market capitalization of \$24.2 billion. That is how much you would need to pay for total 100% ownership of this company (assuming everyone would want to sell you their shares, which is not guaranteed).

The March 2009 Money Magazine lists Citigroup at the top of highest yielding Dow stocks with a dividend yield of 17.4% (at a price of \$3.67 a share). Wow! Who cares what the share price is when a company is giving you a 17% return! How can they give back so much money when their earnings are negative? By contrast General Electric had a dividend yield of 9.5% at a price of \$13.03 per share. Note the dividend yield is a percentage; divide the dividend per share by the price per share, so working backwards we get that Citigroup was paying \$0.63 per share while General Electric was paying \$1.24 in dividends per share. In the next issue of Money magazine, Citigroup has disappeared from the list of highest yielding Dow stocks and General Electric is at the top with a 14% dividend yield at a price of \$8.85 per share. Again multiplying share price by dividend yield we get a dividend of \$1.24 per share.

What happened to Citigroup's dividend? The share price of Citigroup is listed at \$2.14. Dividing the dividend of \$0.63 by \$2.14 we get a dividend yield of 29.4%, meaning they should be at the top of the list! The point is that the dividend yield is computed using the most recent dividend per share. So as the share price fluctuates according to the whims of the market, the dividend yield moves with it. Citigroup's share price had plummeted to such low levels that the dividend yield skyrocketed (note that the actual dividend is kept fixed in these calculations). Thus Citigroup simply readjusted their dividend payout for 2009 to more accurately reflect their lack of earnings, and so that their yield did not look so outrageously inflated. The stock quote above lists the new dividend per share; hopefully you now are financially literate enough to find this statistic!

Sapere Aude!