PAAY stands for Percent Above Average Yield. It is a measure of how much a stock’s yield is above or below its usual yield, and I use it to help me find undervalued stocks.
We all know that the stock market, and individual stocks, go up and down every day. And often those moves are not based on the underlying fundamentals of any particular company. The stock price may be down even as the company continues to perform well. This could be a good buying opportunity, and you can use PAAY to find them.
PAAY is calculated by subtracting the stock’s average from its present yield and dividing that number by the average yield. If stock XYZ usually has a yield of 3.0%, but when you look at it the yield has risen to 4.0%, that stock will have a relatively high PAAY of 33%.
(4.0% – 3.0%)/3.0% = 33.33%
A large positive PAAY like this indicates a potentially undervalued stock. However, for it to truly be the fundamentals must still be sound and the dividend must be safe. Otherwise the drop in price and the high PAAY might just be pointing out a stock that is in trouble, one you should stay away from. Therefore, in order for PAAY to be useful it should only be used with Dividend Growth Stocks. Dividend growth stocks have proven, with their record of uninterrupted dividend growth, that they are committed to the dividend, that it will likely to continue to grow, and that the fundamentals of the company are sound. Yes, a dividend growth stock may cut its dividend, and in this case the PAAY may have given you a false buy signal. But this is relatively rare, and it’s more likely that the drop in price, which caused the higher yield and the high PAAY, in time will reverse and begin to rise again, in which case the PAAY pointed out a great buying opportunity.
PAAY can be used either for reinvesting your dividends, or for buying new positions. In each case I’m looking to take advantage of some short-term price moves which might reverse quickly. Therefore, I use the one-year average yield. This can catch price moves which may only last a month or two before reversing back up, and it’s a great way to increase your dividend income by buying more shares of solid dividend growth stocks at a relatively high yield. And as the price recovers you get a nice capital gain which helps with your total return.
I use PAAY for many of the portfolios here on the PTI website, including the Dividend Champions by PAAY and the Dividend Aristocrats by PAAY. How it is used is explained on each of those portfolios’ pages. I also use it in the KISS portfolio for reinvesting my dividends.
To learn more about PAAY you may wish to read two articles which I wrote for Seeking Alpha. The first one discusses how to use PAAY to find buying opportunities, while the second one describes how to use PAAY to reinvest your dividends. In addition, on this website, you can follow the portfolios which make use of it. The best part is, with a subscription to the newsletter you can follow along as I build the PTI Portfolio, in part using PAAY.