Beyond P/E ratios: How to uncover dividend opportunities

At Fly High Investing, we focus on a comprehensive view of earnings ratios to evaluate the sustainability and potential of dividend-paying stocks. You might be interested to find that we also use the price-to-earnings (P/E) ratio as a metric to determine whether a stock might be over or undersold, however it is not the core factor in our decision-making process. Instead, we emphasize earnings ratios, such as adjusted earnings and net earnings, as these give a clearer picture of a company’s profitability and its ability to continue paying dividends. Ready Capital (RC) provides an excellent case study for how we apply these principles in practice.

On August 7, 2024, Ready Capital reported earnings of just .07 cents per share, falling well short of expectations. This led to a rapid decline in the stock price, down to 8.10 per share, despite its net book value of 12.97 per share. The market’s reaction was in our estimation an overcorrection, as it often is when earnings reports disappoint. At Fly High, we look beyond this initial reaction to assess the company’s actual earning potential and dividend sustainability. We gauge whether the stock is truly oversold by focusing on its earnings ratios, which show how much of the company’s profit is being generated and returned to shareholders. In this case, Ready Capital’s earnings miss and stock price dip present a potential opportunity, as the fundamentals suggest the stock may have been unfairly punished.

Comparing Ready Capital to the broader market, particularly the S&P 500, highlights the differences in valuation metrics. Let’s explore this…

As of writing this, the S&P 500 has an average P/E ratio of around 30, many of the high-dividend-paying stocks in Fly High Investing’s portfolio, including Ready Capital, have much lower P/E ratios and our overall portfolio averages 8. A low P/E ratio signals that the market might be undervaluing the company’s earnings, but it is our deeper analysis of the company’s earnings ratios that confirms its true value. For example, a stock with a P/E of 10 would translate into an earnings yield of 10%, while the S&P 500’s average of 30 yields only 3.3%. This means it would take 30 years of earnings to equal the price you paid for the stock assuming earnings remain constant, and the price of the stock doesn’t change! Worse still the S&P 500 average P/E is 15, so we believe it is overbought. Still, it’s the company’s ability to consistently generate and distribute earnings that matters most, and that’s what we prioritize.

At Fly High Investing, our approach centers on income generation and long-term growth. Over the past five years, our portfolio has generated a 67% increase in income. This is possible because we focus on companies with strong earnings and disciplined dividend policies, rather than simply chasing stocks with low P/E ratios. Understanding how to evaluate earnings ratios is crucial for identifying undervalued stocks, like Ready Capital, that can deliver sustainable dividends and capital appreciation over time. This disciplined focus on earnings-driven decision-making ensures that we continue to grow our passive income stream, regardless of market sentiment.