Screening for Dividends

Equity income is a good choice for conservative investors who need to rely upon their portfolio to provide income to support their lifestyle.

Equity income investing tends to involve a trade-off between capital gains potential and current cash flow to the investor. In a depressed market such as the one we are in now, equity income in “safe” companies offers more potential for capital gains than usual, making dividend investing all the more attractive to the conservative investor.

What About Bonds?

Bonds are good for income too, but the income does not increase (with the possible exception of inflation protected bonds and perhaps some variable rate bonds). Bonds have a definite capital preservation and volatility reduction role in portfolios — and a tax reduction role in the case of municipal bonds. Dividends from successful companies, however, tend to increase over time, helping the portfolio maintain the purchasing power of its cash income stream.

Contribution of Dividends to Total Return:

Various studies suggest that on average, about 1/3 of long-term returns of the overall US stock market come from dividends — more when markets are falling and less when they are rising. With a long-term mean US stock market return in the vicinity of 9%, we might presume an average dividend return of about 3%. The S&P 500 index recently was yielding in the area of 3%.

Safe Portfolio Cash Withdrawal Rate:

The “safe” initial withdrawal rate from a portfolio for a person about 65 years old with the prospect of living to 95 with low probability of outliving assets is about 3%, assuming that the withdrawals will increase by the CPI each year after ithdrawals commence.

So, 3% seems like an important minimum threshold to consider when screening for equity income opportunities among US stocks. If the income from your stocks can fund your cash flow needs without necessitating sale of assets, that would be a good thing.

Super Stringent Screen Results:

We subjected a data base of over 9,500 US stocks to a stringent set of screening criteria to see what might come out the other end. The following list of four securities is not a recommendation, but merely information that you can take on board and consider as potentially of interest:

• Paychex (PAYX)
• Hudson City Bancorp (HCBK)
• Mine Safety Appliance (MSA)
• AFLAC (AFL)

The Screening Criteria:

These criteria are too strict to be useful in constructing an entire portfolio, because hardly any security can pass the test. Nonetheless it was our goal to see if any could.

Seven passed the quantitative criteria below. When we reviewed their charts, only four looked like they were going up or making a serious effort at going up.

Buying stocks when both the fundamentals and the price behavior are positive is a good approach — safer than buying stocks with positive fundamentals and negative price behavior.

• Price > $5
• Current Yield > 3%
• Current Yield > 3-yr Average Yield
• Mkt Cap > $250 million
• Daily $ Volume > $1 million
• EV/EBITDA < 12
• Tangible Equity > $0
• LTD < 0.5 x Tangible Equity
• Total Liabilities < Tangible Equity
• Free Cash Flow Last Quarter > $0
• Free Cash Flow Last Four Quarters > $0
• Free Cash Flow First Prior FY > $0
• Free Cash Flow Second Prior FY > $0
• Free Cash Flow Third Prior FY > $0
• Dividend Most Recent Quarter > $0.01
• Dividend First Prior Quarter > $0.01
• Dividend Second Prior Quarter > $0.01
• Dividend Third Prior Quarter > $0.01
• Dividend First Prior FY > $0.01
• Dividend Second Prior FY > $0.01
• Dividend Third Prior FY > $0.01
• Dividend Fourth Prior FY > $0.01
• Dividend Fifth Prior FY > $0.01
• Dividend Sixth Prior FY > $0.01
• Dividend Seventh Prior FY > $0.01
• Dividend Growth for Prior Four Quarters > 3%
• Dividend Growth for 1 Year > 3%
• Dividend Growth for 3 Years > 3%
• Dividend Growth for 5 Years > 3%
• Dividend Growth for 7 Year s> 3%
• Sales Growth for Prior Four Quarters > 3%
• Sales Growth for 1 Year > 3%
• Sales Growth for 3 Years > 3%
• Sales Growth for 5 Years > 3%
• Sales Growth for 7 Year s> 3%

These criteria a too tough to be practical. You can’t build a portfolio out of four stocks. You need to accept more warts and blemishes on your companies to get enough diversification. Nonetheless, it is interesting to see which companies can satisfy these criteria.

Effect of Lightening the Criteria:

If we eliminate the Balance Sheet criteria, 32 companies pass. If we further eliminate the free cash flow criteria, 71 companies pass. And if we limit the dividend and sales criteria to a five year period instead of a seven year period, 89 companies pass. Lastly, if we eliminate the EV/EBITDA valuation criteria, 116 companies pass.

The Companies That Passed Our Screen:

Here are business descriptions, price charts, and fundamental data for the four companies that have met the high consistency hurdles posed by the filter criteria we used today. The business descriptions are from Corporate Information.

Reiterate — these are not recommendations, just filter results.

The first panel below the main panel shows the relative percentage price performance of the company stock versus the S&P 500 index. The second panel below the main panel shows the relative percentage price performance of the company stock versus the Barclay’s US Aggregate Bond index.

Paychex:
Business Description: The Group’s principal activity is to provide payroll, human resource and employee benefit outsourcing solutions for small to medium-sized businesses. The services include payroll processing, tax filing and payments, retirement services administration, employee benefits administration, regulatory compliance, workers’ compensation insurance and comprehensive bundled human resource administrative services. Through the Paychex online, the Group provides Core Payroll services such as Online Payroll, Internet Time Sheet, Internet Report Service and General Ledger Reporting Service. Outsourcing of the payroll and human resource functions allows small businesses to minimize the compliance risks associated with changing administrative requirements and statutory tax regulations. The Group operates in the United States.

click on images to enlarge

(fundamental PAYX data from Yahoo)

Hudson City Bancorp:
Business Description: The Group’s principal activity is to offer traditional deposit products, residential real estate mortgage loans and consumer loans. It purchases mortgages, mortgage-backed securities, securities issued by the U.S government and agencies and other investments. The Group serves as the holding company of its only subsidiary, Hudson City Savings Bank. It operates through 127 branches in the New York metropolitan area, 93 branches located in 9 counties throughout the State of New Jersey. In New York State, it operate 9 branch offices in Westchester County, 9 branch offices in Suffolk County, 1branch office each in Putnam and Rockland Counties and 5 branch offices in Richmond County (Staten Island).

(fundamental HCBK data from Yahoo)

Mine Safety Appliances:
Business Description: The Group’s principal activities are manufacturing and marketing health and safety products. These products include respiratory protective equipment, instruments to monitor and analyze workplace environments and control industrial processes, thermal imaging cameras and personal protective products such as hearing protectors and fall protection equipment. The Group products are used by workers in the manufacturing, mining, chemicals, petroleum, construction, transportation and hazardous materials clean-up industries, fire departments and public utilities. The Groups sales and distribution is carried out through 400 dedicated associates. It operates in North America, Europe, China, South Africa, Brazil, Australia, Peru, India & Argentina.

(fundamental MSA data from Yahoo)

AFLAC:
Business Description: The Group’s principal activity is to provide supplemental health and life insurance services through its subsidiary American Family Life Assurance Company of Columbus. The Group also sells care plans, general medical expense plans, medical/sickness riders to cancer plan, living benefit life plan, accident plan, sickness and plan in addition to the cancer plans. The cancer life insurance plans provide a fixed daily indemnity benefit for hospitalization and outpatient services related to cancer and a lump-sum benefit upon initial diagnosis of internal cancer. The Group’s hospital indemnity products provide fixed daily benefits for hospitalization due to accident or sickness. The other types of supplemental health insurance are hospital intensive care, accident and disability, hospital indemnity, long-term care, short-term disability and dental plans. The Group operates in the United States and Japan.

(fundamental AFL data from Yahoo)

Comments

[Lightway:]

Glad to see Hudson City Bancorp in the screen. Finding good dividend financials right now has been an extreme challenge. I guess the term "financials" is being redefined as we speak, since that includes both banks, investment banks, or, the most common, hybrids of the two.

I'm personally looking to find some "boring" bank dividend stocks, hoping the new financial model becomes a much more conservative one, where banks and investment banks are clear cut in their definition and purpose, and mutually exclusive from each other.

I'm personally long AFLAC and PAYX

Apr 13 02:14 PM

[whidbey:]

Good stuff for the long run.

In the short run stay in cash to avoid whipsaws, and they will test the old lows this year.

We should not ignore the possibilities of precious metals since the real action is in liquidity madness as Congress and Obama seek to change the way we were.

Apr 13 02:39 PM

[David Allen:]

Paychex will have good upside and growth potential, as more and more businesses will find it cheaper to outsource their payroll and accounting to firms like Paychex and Automatic Data.

Apr 13 04:59 PM

[granger:]

Great info.

Got lucky and used the lower openings last week and picked up some AFL just above 20.25. Only got on about 25% of what I wanted, but will have to wait. Actually took small profits on some late Friday.

I plan to keep therest as a core holding for many years to come.

Apr 13 05:01 PM

[Rob Viglione:]

One thing the financial crash taught me was to value cash flow! Looking forward, sustainable dividend yield is one of my chief criteria for stock ownership.

Companies that retain 100% of earnings are gambling that incremental investment will continue to grow earnings at sufficient ROI to warrant reinvestment. I prefer to take some cash off the table and decide for myself whether or not I want to reinvest.

Apr 14 12:16 AM

[Stro:]

AFL has debt silly. finance.yahoo.com/q/bs...

May 14 10:28 AM

[Stro:]

MSA has debt too!!!! finance.yahoo.com/q/bs...

May 14 10:32 AM