Ask Colin

How is a "low" PE ratio and a "high" dividend yield defined?

I have discussed this in the charting article I wrote for June 2003 Shares.

I also discussed this in part in my Newsletter No 30 as far as PE ratios were concerned.

The guidance from these two discussions is that we need ratios that are significantly cheaper than the market average. How much is significant is a matter of judgement.

For example, the market average PE ratio might be 15 and the market average dividend yield might be 4.5%.

If we found a company that had a PE ratio of 8 and a dividend yield of 6%, that would be OK for me in general terms. However, it would only be a starting point. I would then research the type of company it was and its history of earnings and dividends.

Today, someone asked me about a company that was around these figures. However, it was in the rural sector and its earnings and dividends jump around a lot from year to year. Using historical ratios for just one year is not really applicable here. It works best when the company is a standard industrial where the last year is a good indication of its ongoing earnings and dividends.

The other reason I like to leave the parameters flexible is that we might set them at 10 and 5%. Many people then run those through computers. Where it is a bit silly is that it would not pick up a company with a PE of 10.1 and dividend yield of 6%. The extra 0.1 PE ratio is quite insignificant. Likewise it would ignore a company with a PE of 10.5 and dividend yield of 6%. I would want to consider this one too - the extra yield may be an acceptable trade-off with the higher PE ratio.

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