A dividend is just one of many ways a company can reward its shareholders by paying them out in cash. The investor can then choose to take the cash and run, reinvest it in the company, or invest it in a different company. After a company has made their net income for the quarter they have the choice of what to do with it and the choices are usually to either plow the money back into the business for other investments or pay some of that money back to the shareholders in the form of a dividend.

Most Recent Dividend Announcement

Gilead Sciences (GILD) recently announced a quarterly dividend of $0.47 per share with an ex-dividend which was set for December 13^th, making the must own date December 12^th. This dividend announcement is on par with what was announced the previous quarter and will be payable to shareholders on December 29^th. The dividend is currently good for a 2.4% yield on today's share price of $76.44. Based on trailing earnings, the dividend is good for a payout ratio of 17% which is pretty good. From a cash flow perspective the company has paid $2.5B in dividends over the past twelve months on operating cash flow of $18.1B which is good for a 14% operating cash flow payout ratio.

Potential Future Dividends

The company has been increasing its dividend for the past two years so there isn’t much history to give investors a warm-fuzzy feeling. The company is projected to earn $10.85 per share in earnings for next year and if the EPS payout ratio remains the same at 17% then the company should distribute about $1.85 (or a 2% decrease) annually starting second quarter of 2017 when they usually announce their dividend. But I doubt they will decrease their dividend, that would definitely not sit well with investors. That amount seems pretty sustainable and I do believe the 17% payout ratio is sustainable for the long-term.

Earnings growth projections for the company are pretty horrible for a biotech with a one year growth rate of -5.7% and five year growth rate of -0.6%. With that said, I believe a 1% increase to the dividend next year would be much better because throw investors a bone at a time the company is not doing so well. A 1% increase would constitute an annual dividend of $1.90 for 2017 if it increases the dividend in 2017.

Dividend Valuation

Now let's get to the meat and potatoes, the dividend valuation model to determine a price that the stock should be at based on the dividend alone. Since I just mentioned that the company has been increasing its dividend for the past two years we know that it has a pretty short history of increasing it and should continue to increase it going into the future. The dividend growth model equation takes the form of:

Where D is equivalent to the current dividend, R is the rate of return desired by the investor, and G is the anticipated growth rate of the dividend. For the D value I'm going to use the existing dividend rate of $1.88. For the R value I’m going to use 2.2% because it is the US GDP projection given by the IMF. For the G value of the equation I'm going to use a dividend growth rate of 1% because I definitely believe the company could increase the dividend by that much at the beginning of next year to keep investors happy. When you plug and chug all the numbers you get a stock value of $156 which makes the stock undervalued by about 105% from today's price of $76.44. For reference, the 52-week high on the stock was $108.63 during this time last year.

Conclusion

The dividend discount model is just one of many ways to value a company and should be taken into consideration while trying to evaluate a company. Assumptions are always made while using valuation models and I believe I’ve selected some of the most conservative criteria for the valuation in this article. This valuation model shows the value of the dividend stream and that the stock is undervalued based on the dividend alone. The company has been around for quite some time and can definitely afford to increase the dividend when 2017 comes around.

The company currently trades at a trailing 12-month P/E ratio of 7.09, which is inexpensively priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 7.05 is currently inexpensively priced for the future in terms of the right here, right now. Next year's estimated earnings are $10.85 per share and I'd consider the stock inexpensive until about $163. There are many ways to value a stock; with the dividend, P/E, and PEG methods being a common place to start.  

I actually initiated my position in Gilead in early September of 2015 and have been pretty upset with the purchase thus far. So far I'm down 7.5% on an annualized basis but will continue to purchase shares as long as they are below $85 because I believe that is where it offers exceptional value. I've selected $85 because it is the average price at which I currently own my shares. But I do believe that it offers value until around $90 which happens to be the midway point of the 52-week range.

When it is all said and done, it matters what the stock has done in an investor's portfolio at the end of the day. For me, Gilead is my largest position and has been horrible as I'm down 8.9% on the name including reinvested dividends, while the position occupies roughly 17.8% of my portfolio. I continue to believe in it as a wild card name because it has been beaten down and offers value. I own the stock for the wild card portion of my portfolio, and I will continue to hold onto the stock for now. My portfolio is up 10.1% since the inception, while the S&P 500 is up 4.1%. Below is a quick glance of my portfolio and how each position is performing. Thanks for reading, and I look forward to your comments.