@Kithsiri wrote:Is Averaging just a Mathematical illusion only ?
Is Declining Dividend Ratio can be a sign of concern always ?
1. Is Averaging just a Mathematical illusion only ?
It depends on the following factors -
(a). The opportunity cost of funds i.e. say 1 year FD rate. (understand the Risk/ Return profile)
(b). EPS Growth rate of the company (& prospects of the Industry / Business they are in)
(c). The current P/E of the company.
In the above question i presume you mean averaging (buying) when price is going down.
so, as a general rule of thumb, 100 divided by (a) = your required p/e at current value. this is equilibrium means your return from the opportunity cost of capital (a) = the rate of the company's earnings at current stock price (c). Therefore, provided (a) and (b) dont change, a change in the stock price down (c) means it makes sense to average down and buy, based on fundamentals of the Macro & Company conditions.
If (a) is going up and (b) is going down - then averaging down becomes a mathematical illusion. If (a) is going down and (b) is going up, then any reduction in (c) maybe a buying opportunity i.e. averaging down and buying.
If (c) is less than 100 divided by (a), and provided that of course (b) is stable, then any further downward movements in (c) should be perceived as good to average.
2. Is Declining Dividend Ratio can be a sign of concern always ?
It depends. If declining dividends is due to declining earnings, then it may be a cause for concern. but it could be temporary due to the company's business / growth cycle. You have to observe a trend before you can make a decision based on 1 (b) before you can come to a conclusion. On the other hand, a declining dividend payout / ratio due to company's internal need for capital for growth purposes may be a good thing, especially if they can grow earnings at a faster rate in the future by cutting down dividends / or taking on less debt. This means that part of your reduced dividend is re-invested in future growth of the company. Especially if 1 (b) is promising, this could lead to an multiplier effect on earnings and future dividends.
Very important to read and understand the Cash Flow Statement in the AR to get a feel of the cash flows, Capex etc.
Timeframe for all of the above to be meaningful - Medium to Long term.
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