A while back, as part of an article I wrote examining some mREITs, I developed a simple comparison chart of Yield vs. Dividend vs. Price (YDP chart) that both myself and my readers found useful. These charts offer a clear visual tool to help examine when share price was getting ahead or falling behind the particular investment's traditional market valuation.
Reasons For Using This Screen:
Because both Royalty Trusts and mREITs are generally dividend income investments, I decided to apply this screen to some royalty trusts since they fit in that same category. A word of caution is advisable before we proceed further. This is only a screening tool. It must be combined with more in depth evaluation of a full spectrum of traditional fundamental metrics and technical chart trends in order to make a fully informed investment decision.
How The Screen Works:
Yield = Distribution/share price ( Y = D/P). This is a fundamental inverse mathematical relationship. For a fixed distribution, yield will vary inversely to share price change.
For example, a reliable steady dividend distribution of 3% from a mature company in a mature industry (a cash cow) will generally see its share price steady along with the steady dividend. So long as the distribution remains constant, any change in the effective yield is solely a reflection in changes in share price. Simply put, a $10 stock with a $0.30 annual distribution is a 3% yield. If the share price moves to $15 but distribution remains at $0.30, then the yield is reduced to 2%.
So long as the distribution remains constant, any change in share price directly reflects a change in the marketplace's premium it offers for this distribution. Changes in the marketplace premium (discount) may be due to factors such as;
- Prevailing market interests rates.
- Perceived sector/industry risk to the distribution.
- Perceived internal company risk for maintaining the distribution.
- Change in demand whereby the number of investors competing for the rate drives share price up/down.
- Temporary unbalance of price versus distribution.
This last factor in the above list is particularly important to us. Shares temporarily out of their tradition balance with yield are signals to buy or sell for gains beyond the income stream from their distribution (or to use covered options to increase income while continuing to hold shares for the dividend income). It is also important to discover when changes are not due to a temporary imbalance but instead signal one of the other factors entering into play. Furthermore, when a large number of companies in the same category all show YDP trends departing in the same direction from their historic trend, it helps identify an external factor driving the change rather than something internal to a given company. The YDP chart can be a very useful tool in helping to discern many subtle factors responsible for changes in yield independent of the pure mathematical relationship.
Because all 5 of the listed factors, and more, influence departures from the pure inverse Y=D/P relationship, it can be difficult to filter the signal from the noise. Yet this is critical both for understanding what has driven the share price historically, and thus, will likely do so in the future and for a context in evaluating the current price of shares relative to the marketplace fair value historically. The YDP screen charts presented here help to make this a more visual task and thus more intuitive.
The comparison of historic and current trends in share price, dividend distribution and effective yield provides a strong visual graphic understanding of how the market values a given income producing investment over time. This view of historic data begins with the assumption that for a constant distribution, share price and yield rate have an inverse relationship (the Y=D/P factor).
Using this initial assumption and fundamental mathematical relationship, dividend income investments are evaluated to see when the price to distribution ratio is getting ahead or behind the historic market valuation of the fundamental cash distribution.
A Look At BP Prudhoe Bay Royalty Trust:
With this preamble out of the way, let's examine what the screen charts show us for BP Prudhoe Bay Royalty Trust (BPT).
Prudhoe Bay Royalty Trust is a very focused investment. The company holds overriding royalty interests constituting a non-operational interest in minerals in the Prudhoe Bay oil field located on the North Slope in Alaska. Not only is it all oil with associated gas, it is also limited to a single oil field. This is very unusual, in fact it may be unique other than possibly some tar sands development or a recent shale oil/gas project. Clearly, such an "all the eggs in one basket" focus adds significantly to risk. Yet, BPT has never exhibited any discernible sign that such added risk plays a part in its price valuation.
Focusing on the YDP chart, we can see a few expected features right away. As anticipated, here is generally a clear inverse relationship between share price and effective yield rate of the distribution. However, in late 2005 we can see a sharp rise in yield greater than the inverse decline of share price. This sharp trend deflection also is a reversal from declining yield against both rising price and steadily rising distribution. The departure point is followed by a continuing rising yield in step with rising distribution.
Emphasizing the importance of the anomalous activity is that after the sharp reversal, both distribution and yield move upward in parallel trend, while share price remains relatively flat. This later behavior after the anomaly is in accordance with Y = D/P and thus shares are fairly priced by the marketplace for this post anomaly period and continuing into early 2007. This can prove useful in establishing a fair value for use at later times during other similar periods of corresponding distribution and effective yield.
The small pull back in distribution in the first quarter of 2007 triggered a strong reaction in the marketplace. Share price begins a rising trend that initially outpaces steepening of the distribution payouts. This is seen in the initially falling yield rate against these other two rising trends. The market pricing soon rationalizes itself to price and distribution as evidenced by the flat yield curve trend from mid 2007 with a continuation of the 3 curve trends relative to each other into mid 2008. Again, this stable correlation of the 3 suggests the marketplace is trading at a fair value and not out of balance for this period. Thus another historic benchmark for YDP pricing is documented.
The mid 2008 peak distribution to early 2009 distribution trough is accompanied by proportionate adjustments in share price and yield, another sign the market is efficiently adjusting these 3 elements according to the Y = D/P relationship and thus can be considered at fair price.
At first glance, the rising share price mirrored by initially declining and then stabilized yields accompanied by rising distributions gives the impression of being in accordance with the YDP relationship. Two things stand out to question this first impression. First, share prices are rising considerably faster than distributions, unlike the parallel curves of the prior periods. Second, the absolute share prices quickly rise above all prior historical levels for corresponding historical distribution levels. This is a warning signal that a price bubble may be forming.
The sharp decline in mid 2012 appears to be the bursting of that bubble. The return of share price to a level in historic correlation to the distribution amount and yield rate suggests the shares may be at fair price or slightly discounted currently. Further fundamental analysis is advisable to confirm this possible current under-value pricing for BPT shares.
BPT data by YCharts
I hope this exercise has helped you see the usefulness of the YPD chart in identifying historic trends and fair price points along with identifying possibly anomalies which suggest further research such as the possible bubble and current over-correction BPT is now experiencing.
I will be providing a series of articles using YDP chart screening analysis for a spectrum of dividend income investments over the next several weeks, possibly expanding into a regular weekly feature. As this is a new tool I am still developing and learning to use myself, your comments and questions regarding the chart and its uses are welcome. I suggest that the interested reader review my earlier work on YDP charts in Double-Digit Yields. Be Sure You Get The mREIT Facts Before You Leap to get further examples of the charts and their interpretation for dividend income equity investments.
Disclaimer: I am not a licensed securities dealer or advisor. The views here are solely my own and should not be considered or used for investment advice. As always, individuals should determine the suitability for their own situation and perform their own due diligence before making any investment.