Wednesday, July 30, 2008

My Dividend Growth Plan - Stock Selection

In my previous article I started discussing my dividend growth plan in more detail, by focusing on my strategy. Today I will be focusing on my stock selection criteria.

The type of investments I am focusing on involve dividend paying companies, which have a history of uninterrupted dividend growth. There are several publicly available lists out there including the dividend aristocrats, high-yield dividend aristocrats, dividend champions and the dividend achievers. The first three lists consist of stocks which have increased their dividend payments to shareholders for more than twenty-five consecutive years. The broad dividend achievers list focuses on companies which have increased their payments for at least ten consecutive years. The companies that have been able to do that are believed to have a solid business model and smart management. In addition to that these companies have a proven track record which shows that their business model is able to consistently support an increase in dividend payments to shareholders. This also shows that management is committed to enriching the shareholders and not enriching themselves. In a period of time where total CEO compensation runs in the millions of dollars regardless of company performance, it pays to know that the executive team is committed to sharing the company’s wealth with its owners - the investors.

The above mentioned lists are only a starting point for the dedicated dividend investor. I do not want to blindly purchase all stocks without understanding their business and without checking several financial characteristics of the companies. In my analysis of dividend stocks I check several parameters:

EPS- The earnings per share indicator is calculated by dividing the total amount of net income for one year to the total number of shares outstanding. I am normally looking for an increase in EPS over the past ten years. A company that cannot increase its EPS over time, will not be able to sustain the growth in its dividend payments to shareholders.

ROE – The Return on Equity is calculated by dividing the total amount of net income for a given year over the amount of owner’s equity on the balance sheet at the end of the previous period. I do not look for specific numbers in this indicator, but focus exclusively on its trend. Most stocks will have a flat ROE over time, which is fine with me. A red flag for me is a decreasing ROE over time.

DPR- I calculate the dividend payout ratio by dividing the DPS over the EPS. I am generally looking for a DPR that is below 50% in most companies. However, if a corporation has been able to maintain a higher DPR over time due to the nature of its business or the nature of its legal structure, I would consider buying a stock with a much higher DPR. A rising DPR is generally a red flag for me. This shows me that there is not much room for future dividend growth. In addition, stocks which have a highly unusual for them DPR indicate a higher risk for dividend cuts.

DPS – I generally look for an uninterrupted growth in dividends every year for more than ten years, preferably twenty-five. A company which hasn’t been able to at least pay a stable dividend without cutting it in difficult times is automatically off of my radar. General Motors is one stock which I won’t touch, since it has exhibited a lot of fluctuations in its dividend payments over the years.

Valuation- After checking the trends of earnings, roe, dpr and dps I assume that these would continue to be doing ok or not ok for the foreseeable future. I then look for stocks with a price earnings ratio of less than 20, dividend yield which equals at least the yield on the S&P 500 and a dividend payment ratio which does not exceed 50%. After buying a stock, I would “forget” about it and let the dividends reinvest automatically into more shares. Even if a company becomes overvalued in terms of super high P/E ratio, I won’t consider selling. I would consider holding forever in most situations.

For a sample dividend analysis of a stock, check out Analisys of Johnson & Johnson (JNJ).

Next Week I will be discussing the diversification part of my dividend growth plan.

Relevant Articles:

- Long term returns of S&P high-yield aristocrats
- Why do I like Dividend Aristocrats?
- Why do I like Dividend Achievers
- Dividend Champions Watchlist

6 comments:

  1. Very through article. Great read!


    Best Wishes,
    Dividends4Life

    ReplyDelete
  2. D4L,

    Thanks for stopping by. I have two more articles on this subject that should hit the blog over the next few weeks..

    ReplyDelete
  3. This is an interesting read in deed. I am also a dividends kind of investor and your article has given me some insights on how to better screen dividend paying stocks next time.

    ReplyDelete
  4. Stockscreener,

    Thanks for stopping by and commenting on my post. I definitely think that its best to find a method for screening stocks that does not contradict with your beliefs and your temperaments.

    Best Regards,

    DGI

    ReplyDelete
  5. Thank you so much for summarising your selection criterea. I am starting out in the world of stock after reading some interesting books recently that have opened my mind to a more self controlled route towards establishing my retirement portfolio.

    I would like to know where you find the historical information on these companies so that you can look at trends as part of your analysis?

    I have signed up with TD Waterhouse (I live in Canada) and they have tons of info but I can;t seem to find enough to come up with all of the data you mentioned in this post.

    Any help would be great!

    ReplyDelete
  6. Thanks so much for putting together this incredibly helpful series of posts. I live in Canada and have signed up with TD Waterhouse to start investing in stocks, but can't seem to find all of the historical data that you use for analysing trends. Where do you find it?

    Please keep up the great blog, I have become a regular reader.

    ReplyDelete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

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