Ensure a hefty dividend is sustainable

Motley Fool

Q: I found a stock that’s priced at less than $1 per share, but it pays out more than $1 per share in dividends. Good buy? Bad idea? — E.P., Sacramento, California

A: Bad idea. Stocks trading for less than about $5 per share are penny stocks, which tend to be volatile and risky.

You want dividend payers to be generating more in earnings per share than they’re paying out in dividends so that their payouts are sustainable and unlikely to be reduced or eliminated. Hefty dividends are great, but a company needs to be strong enough to sustain them.

Fool’s School: Profit Margins

For best results when evaluating, investing in and following stocks, you should know your way around the income statement (sometimes called the statement of operations), which summarizes sales and profits over a period such as three months or a year.

Consider McDonald’s income statement for 2017. At the top, you’ll find net revenue (sometimes called sales). For McDonald’s, it’s $22.8 billion. As you work your way down the income statement, various costs will be subtracted from revenue, leaving different levels of profit. The item you’ll find just under revenue is “cost of goods sold” (sometimes abbreviated as COGS or called cost of revenue), representing the cost of producing products or services sold. For McDonald’s, it’s $12.2 billion. Subtract the COGS from revenue, and you’ll get a gross profit of $10.6 billion.

To find the gross margin, which reflects the costs of production relative to revenue, divide the gross profit by revenue. Dividing $10.6 billion by $22.8 billion yields a gross margin of 0.46, or 46 percent. It’s often illuminating to compare the results with peers. For example, gross margin is 58 percent for Wendy’s and 60 percent for Starbucks.

Subtracted next are the remaining costs involved in operating the business, such as support-staff salaries, utility bills and advertising expenses, leaving the operating profit. McDonald’s operating profit is $9.6 billion. Dividing this by revenue yields an operating margin of 42 percent. Crunching older numbers reveals that McDonald’s operating margin is up from 28 percent two years earlier, reflecting great improvement. (Both Wendy’s and Starbucks sport operating margins of 18 percent.)

Finally, after items such as taxes and interest payments are accounted for, we arrive at net income, near the bottom of the statement. McDonald’s is $5.2 billion. Dividing that by revenue yields a hefty net profit margin of 23 percent. This number reflects how many pennies from every dollar of sales McDonald’s keeps as profit. (Wendy’s net margin is 16 percent, and Starbucks’s is 13 percent.) When it comes to profit margins, McDonald’s is strong.

Name that company

I trace my roots to 1955, when the United Business Services company, run by two Kansas City, Missouri, brothers, offered tax-preparation services to its clients. Revenue more than tripled in a year. I started offering my services in cities where the IRS was discontinuing free tax-prep services, and I soon adopted the franchising model. My services became more computerized in the 1980s, especially after I bought CompuServe. Now based in all 50 states and having about 12,000 offices and 70,000 tax pros worldwide, I’ve prepared more than 720 million tax returns. I offer tax-prep software, too. Who am I?

Last week’s answer

I trace my roots to 1972, when a guy founded me as a mail-order business to sell small telescopes. Over time, I offered more and more products for amateur astronomers. I’m known for innovation, such as my telescopes that feature autoguiding systems to easily align on objects of interest. Today, based in Irvine, California, I’m the world’s leading designer and maker of telescopes, and I offer many binoculars and optical accessories, too. In 2013, I merged with Sunny Optics, a subsidiary of a Chinese company. My brands include Coronado, SolarMax, LightBridge, LightSwitch, Wilderness and Astro. Who am I? (Answer: Meade Instruments)