Investment Strategy: Buy stocks with high dividend yields

The dividend yield is dividend per share divided by the price per share. The dividend yield is also called the dividend-price ratio. The dividend per share is the dividend for the previous year, while the price per share is the current price on the stock market. Instead of dividend per share for the previous year, estimated dividend per share for the next year might be used.

A high dividend yield means that a stock is under priced or that the company is facing problems. Similarly, a low dividend yield might be a sign that a stock is over priced. To determine the health of a company you must check the other fundamental parameters.

The dividend yield of the Dow Jones Industrial Average has fluctuated between 3% and 6.0%. The highest Dow Jones dividend yield was about 15% (1932), and the lowest dividend yield of the DJIA was below 1.5% (2000). At the moment (April 2010) the dividend yield of the DJIA is about 2.7%. It is also important to notice that a profit can be either reinvested in the business (called retained earnings), or it can be paid to the shareholders as a dividend. Therefore the dividend yield might be zero. Well established companies usually have higher dividend yields. Growth oriented companies usually have lower dividend yields.

Investment strategy: Buying stocks with low price to sales ratios

The Price-to-Sales (or Price/Sales or P/S) ratio is defined as (Market Capitalization)/(Sales). The market capitalization is the current price of a share multiplied by number of shares. The sales is the revenue from sales for the previous year. This ratio could be also calculated as (Share price)/(Sales per share).

P/S ratio measure how much is the market willing to pay for the each dollar of sales. For example, if the P/E ratio is 15 then investors are willing to pay 15$ for each dollar of sales. Low P/S ratio might indicate that the company is either undervalued or in troubles. It is necessary to check other parameters to see which is true. Price / Sales could be used as a substitute for a Price to Earnings ratio when the earnings are negative. The Earnings could be negative because it is calculated as Sales-Expenses. It is important to compare P/S ratio to the P/S ratios of other companies in a given industry. It is also necessary to check for trends of this and other ratios. Some companies have cycles in earnings and sales. There might be more expenses in one year than in the previous one. At the same time the company might have more sales than in the previous year. In that case P/E ratio could be low or even negative, while the company is actually getting better.

It is important to notice that low Price to Sales ratio might mean that there is something fundamentally wrong with that company. Always assume that there is a reason why the company has small P/S ratio, and look for parameters confirming that. If you find little or no evidence that the company is in troubles, then consider this as a buy signal.