Question

You own a stock of a Fortune 500 corporation. During the last three years, earnings have grown at 8% annually (compounded). The company leads in its segment and pays a dividend which offers a 3% return on the value of the stock, which is now 25% higher than when you bought it 3 years ago. A major article in the Wall Street Journal raises questions about I.T. overspending for this company and the stock price drops to a 3 year low in a week. What do you do with your holdings AND WHY?

Answer 1

EPS has grown by 8% compounded in the last 3 years. The value of the stock has also risen by 25% in 3 years which implies a compounded growth of (1.25)^(1/3) - 1 = 7.77% per year.

So the growth in value of stock has tracked the growth in EPS. Also the dividend yield is 3% on a consistent growth, which also implies that dividend growth has ben also ~ 8% per annum.

The drop is stock value is a momentarily drop and with the growth expected to continue in the future and dividend growth intact, the fair value of the stock is still intact and is at a level higher than the current low value. So as an investor we should keep our holdings of the stock and if possible buy more shares at a low value as this might provide us good return in the future.