Monday, April 7, 2014
How to analyze investment opportunities?
I have discussed before my criteria for screening dividend stocks. The screen narrows down the list of companies to look into more detail, to a more manageable level. In addition, it makes you focus on a set of companies with minimum set of earnings and dividend growth characteristics which are cheaper. Therefore, you would avoid looking at Automatic Data Processing (ADP) at 26 times earnings that yields 2.50%, and instead focus on researching the likes of Chevron (CVX) at 10.70 times earnings that yield 3.40%.
However, it is very important to avoid being short-sighted in regards to stock screens. This is due to the fact that data could not be fed correctly, or it might be misrepresented in the database you are using. For example, some companies usually record one-time adjustments to earnings. Any astute dividend investor should know to exclude these one-time items from the calculation of price earnings ratios. Back in 2010, Coca-Cola had to record a one-time gain on the acquisition of Coca Cola Enterprises North American Bottling Operations. As a result, the stock appeared as a much better bargain in comparison to PepsiCo (PEP). However, this was an illusion, made possible by the one time gain discussed earlier.
The opposite also happens, where a onetime adjustment could push earnings so low, that the P/E ratio and dividend payout ratios scream avoid. In reality, if a one-time adjustment should be taken out, it would usually show that the stock might be a good opportunity.
This is why simply relying on a stock screen to find ideas is not sufficient. This is also why astute dividend investors should research every prospective buy candidate one at a time.
For every company I look at, I focus on several quantitative factors to begin with:
1) Rising earnings per share over the past decade
2) Rising dividends per share over the past decade
3) A stable and sustainable dividend payout ratio
4) Returns on Equity that are stable over time
I also try to read the annual report, and quarterly press releases from the company. There is usually a lot of information, but not all of it can be actionable. I usually try to understand the company’s business while reading reports. However, the thing I am most interested in is trying to determine if there are catalysts for growth in earnings. Only a company that manages to grow earnings per share over time, will be able to afford to increase distributions for its loyal shareholders.
Companies can grow earnings by selling more products, creating new products and services, expanding in new markets, increasing prices, cutting costs, squeezing out inefficiencies, buying back stock, acquiring competitors to name just a few ways. Sometimes, companies can manage to grow earnings per share through a combination of all of the above. For example, Coca-Cola (KO) can earn much more per share, if it manages to convince the average consumer in China and India to drink as many servings of its product as the average US consumer. The average US customer consumes 401 servings of Coca-Cola product every year, compared to 39 in China and 14 in India.
I usually like to see companies which offer a product or service which is unique, and results in repeatable sales to consumers. I also look for companies that have strong brand names for products or services, which are pursued by a fan base of loyal customers. If the customers really like your product or service, and cannot get it anywhere else due to various reasons, you can have very good pricing power. This could be extremely profitable, if there is a limited amount of government regulation. This is referred to as the business having a moat, or strong competitive advantages.
For example, consumers who like Coca-Cola, would be much less likely to buy a Pepsi (PEP). Therefore, if a store does not offer Coke, customers are likely to go to another store to purchase their daily fix. The same is true for other branded products like Hershey (HSY) bars for example.
Full Disclosure: Long KO, PEP, CVX, ADP
- How to be a successful dividend investor
- How to identify your dividend investment goals
- Where to search for investment opportunities?
- When to buy dividend paying stocks?
- Check the Complete Article Archive
This is a guest post by Mike, aka The Dividend Guy. He authors The Dividend Guy Blog since 2010 and manages portfolios at Dividend Stocks Ro...
Dividend growth stocks are the gift that keeps on giving . I like the fact that most of the work in selecting good dividend growth stocks is...
Last week I shared with you the list of 2016 Dividend Aristocrats and its performance over the past decade . In addition, I isolated twenty...
I pick my own dividend paying stocks in my taxable accounts, and wouldn’t have it any other way. I know some of you have mentioned that they...
Mark Seed is passionate about personal finance and investing and is the blogger behind My Own Advisor . Mark is currently investing in divi...
I am a fairly frugal person . An example of that is the fact that I drive a 15 year old car. I would likely keep driving this car until all ...
My retirement strategy is focused on building a dividend portfolio of high quality blue chips, which are reliable dividend payers. For my di...
This is a guest post from Keith Park, who writes about dividend investing on DivHut . Keith has been a dividend growth investor since 2007 f...
This is a guest contribution from Liquid at Freedom 35 Blog . Liquid is an avid investor in the North American financial markets and blogs a...
Oil and gas prices are cyclical in nature. The recent downturn in energy prices that started in 2014 has pushed energy stock prices, earnin...