As you’ll see from the video, this Cliff Note is simple. What we have here is a company with nearly 100% recurring revenue, predictable cash flows, and a leadership position in its industry that has finally decided to start returning a nice chunk of cash to shareholders through a quarterly regular dividend.
At the current price, the dividend equates to about a 13% annual yield. Given the predictability of revenue and cash flows, we think that the risk premium implied by the dividend yield is not commensurate with the low-risk profile of the business.
A Little Context
As you might know, for those companies that pay dividends, the level of dividend yield is directly proportional to the risk of the business. The same as true for bonds that companies issue.
One of my favorite things to do is find stocks trading with high dividends, where the market is mispricing the current or future risk of the business.
If I’m right, the stock price will move up so that the dividend yield will come down as investors figure out that the risk premium implied by the dividend yield is too aggressive.
I like to conservatively assume that a 5% to 7% dividend yield is appropriate for a business that’s relatively stable, with no outsized risks.
Let’s take a look at the math.
If a stock is paying an annual dividend of $2.00 dollar per share and trading at $10, the yield is calculated by dividing the dividend by the price per share. In this case, that would be 20%.
If the stock went to $30, the dividend yield would decrease to 6.7%.
This set-up was the driving force behind our October 2022 Cliff Note #38 on SPOK, now up 115% since being added to the MSMqi.
When we published the note, SPOK was losing money, hated by investors and thought of as a fairly risky investment. However, we believed in management’s restructuring plan, designed to quickly turn the business into a highly predictable business with ample recurring revenue and profitability.
At that time, stock was trading at round $7.00, with a whopping 15% dividend yield. Today, the stock is trading at $16 and a dividend yield of 7.5%.
So, you got more than double on the stock price, while you’ve been locking in a 15% annual dividend for two years. Not bad.
By the way, we still believe SPOK will eventually trade with a 5% dividend yield, translating into a stock price of $25, and that the company will actually raise the dividend in the near future.
Anyways, this post should help you understand why we are excited about a similar set up in Cliff Note #102 and why we made it the spotlight stock for November, as highlighted in the video.
Cliff Notes and Spotlight Stocks
You can find all of our Cliff Notes in a new menu header we recently included on our Substack. As a reminder, every stock that’s added to our MS Microcap Quality Index (MSMqi) comes with a written or video Cliff Note.
Our spotlight stocks are stocks that we want to specifically highlight from the MSMqi. You can follow those at this new menu header. They provide further alpha as seen below.
