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What is the Chowder Rule?

You may often find references to the "Chowder Rule" on Seeking Alpha. This rule was created by a contributing writer by the name of Chowder. He devised this rule to aid in the decision making process while pursuing a dividend growth investing objective.

Keep in mind that this is only one tool you may consider in the investment process. Chowder only employs this rule after researching a company's basic financial strength. In order to qualify, the company must have a credit rating of investment grade; that means a BBB+ or higher from Morningstar. Further research is then conducted which you can read about at, "It's All About the Fundamentals".

The stocks that pass these initial tests are then put to the Chowder Rule. The rule is quite simple. You first take the current yield of a stock and its 5-year dividend compounded annual growth rate (CAGR). Add these two numbers together and that gives you its "score".

Examples

Example 1: Procter & Gamble (NYSE:PG) has a current dividend yield of 3.0% and a 5 year CAGR of 8.8%. That gives PG a score of 11.8.

Example 2: IBM (NYSE:IBM) has a current dividend yield of 2% and a 5 year CAGR of 14.27%. IBM's score is therefore 16.27.

The following guidelines are then applied to the score:

A Chowder score of 12 or greater is required when the current dividend yield is 3% or greater. If the current dividend yield is less than 3%, it must have a score of 15 or higher. Using this scoring system, you may invest in a lower yielding stock if it has higher dividend growth rate to compensate for the lower current income.

In this case, PG with a 3% yield has a score of 11.8 which falls under 12 and therefore fails. IBM, on the other hand, with a dividend yield under 3% and a score of 16.27 and is over 15, so it passes and merits further research as a possible investment.

There is one other exception to this rule. In the case of slower growing sectors, namely utilities, REITs, and telecoms, a Chowder score of only 8 is required. These stocks typically have higher yields and lower 5-year CAGR due to the nature of their industry. You can expect higher current income from these types of investments. The dividend growth going forward will be limited though.

Example 3: AT&T's (NYSE:T) current yield is high at 5.5% but its 5-year CAGR is only 2.4%. Its score is therefore 7.9 and falls just below the threshold of 8.

The Dow Jones Industrial Stocks With Current Yield And 5-Year CAGR.

Using the Chowder Rule, we will now review the 30 stocks that make up the Dow Jones Industrials (NYSEARCA:DIA), using current yields as of January 20th, 2014. (5-Year CAGR as per dividendinvestor.com)

Dividend

5 Year

Chowder

Required

Yield

CAGR

Score

Score

Above/Below

UnitedHealth Group

UNH

1.50%

272.68%

274.18

15

259.18

JPMorgan Chase & Co.

JPM

2.60%

70.63%

73.23

15

58.23

Visa

V

0.70%

45.90%

46.60

15

31.60

Microsoft

MSFT

3.10%

16.28%

19.38

12

7.38

Disney

DIS

1.20%

20.79%

21.99

15

6.99

McDonalds

MCD

3.40%

14.10%

17.50

12

5.50

Goldman Sachs

GS

1.20%

19.00%

20.20

15

5.20

Wal-Mart Stores

WMT

2.50%

14.71%

17.21

15

2.21

Intel

INTC

3.50%

10.50%

14.00

12

2.00

IBM

IBM

2.00%

14.27%

16.27

15

1.27

Chevron

CVX

3.40%

9.08%

12.48

12

0.48

Verizon Communications

VZ

4.40%

3.50%

7.90

8

-0.10

AT&T

T

5.50%

2.40%

7.90

8

-0.10

Procter & Gamble

PG

3.00%

8.80%

11.80

12

-0.20

Home Depot

HD

1.90%

12.21%

14.11

15

-0.89

Travelers

TRV

2.30%

11.60%

13.90

15

-1.10

United Technologies

UTX

2.10%

10.31%

12.41

15

-2.59

ExxonMobil

XOM

2.50%

9.70%

12.20

15

-2.80

NIKE

NKE

1.30%

10.65%

11.95

15

-3.05

Caterpillar

CAT

2.60%

8.41%

11.01

15

-3.99

Coca-Cola

KO

2.90%

8.10%

11.00

15

-4.00

Johnson & Johnson

JNJ

2.80%

7.61%

10.41

15

-4.59

3M

MMM

2.50%

4.90%

7.40

15

-7.60

Boeing

BA

2.10%

4.00%

6.10

15

-8.90

American Express

AXP

1.00%

4.47%

5.47

15

-9.53

E.I. du Pont de Nemours & Co.

DD

2.80%

1.67%

4.47

15

-10.53

General Electric

GE

3.10%

-3.04%

0.06

12

-11.94

Pfizer

PFE

3.30%

-3.46%

-1.60

12

-13.60

Cisco Systems

CSCO

3.00%

N/A

N/A

12

N/A

Merck

MRK

3.60%

N/A

N/A

12

N/A

UnitedHealth Group Tops The List

The first thing that jumps out is the score of UnitedHealth Group (NYSE:UNH). While it has a low dividend yield of 1.5%, it has an amazing growth rate of 272%. Its growth rate was fueled by going from a mere annual $0.03 dividend to $0.50 per share in 2010. That is a 1566.7% one year dividend hike and highly unlikely to happen again. The dividend boost happened because UNH was halted in making large acquisitions and decided instead to pay out its mounting free cash flows to stock holders instead.

Even after stripping out this outlier, UNH has still shown impressive dividend growth as shown below in Fast Graphs. The other thing to note is the lower payout ratio of UNH, currently only at 15%. There is reason to believe that UNH has plenty of room to keep making future dividend raises in the coming years.

Before investing in UNH though, you must consider the political risks. The debate over the Affordable Care Act is far from over and the effects it will have on insurance companies are unknown. Analysts are upbeat over UNH in the long term while it endures some short-term setbacks.

Runner Up: JPMorgan Chase & Co.

Second on the list is JPMorgan Chase & Company (NYSE:JPM) and it presents its own special situation. JPM slashed its dividend going from a $1.52 per share in 2008 to $0.53 in 2009 and lower yet to $0.20 in 2010 due to the financial crisis. The turnaround came in 2011 as JPM paid out $0.80 per share making for a one year increase of 300%.

While JPM has raised its dividend in 2011, 2012, and 2013, you're going to have to decide if the risk fits your investment objectives. JPM just can't seem to catch a break and goes from one scandal and set of fines to the next.

Visa Is Where You May Want To Be

Visa's (NYSE:V) slogan is, "Everywhere You Want To Be." Is your portfolio the place you want Visa to be? The answer might be yes as it may be the most compelling of the top three in the Dow under the Chowder Rule screen.

Visa has a very low yield of just 0.7%, but its dividend growth rate has been great. If the current quarterly payment of $0.40 is maintained through 2014, that will make for a $1.20 per share payment for fiscal 2014 and a 20% raise over last year. Meanwhile, Visa's payout ratio remains low as indicated in the Fast Graphs report below.

Visa requires further research before making any decision. You also need to keep in mind that it has a very short dividend history compared to other Dow stocks. Will Visa be able to keep up the pace of 20% or greater dividend hikes for the foreseeable future? Quite possibly yes, given that the payout ratio is just 17%.

The Others

Microsoft (NASDAQ:MSFT), Disney (NYSE:DIS), McDonald's (NYSE:MCD), Goldman Sachs (NYSE:GS), Wal-Mart Stores (NYSE:WMT), Intel (NASDAQ:INTC), IBM and Chevron (NYSE:CVX) also make the cut being above their respective Chowder Rule required score. Many dividend growth investment portfolios form a core around these mega cap stocks. They merit your attention to see if they may fit your objectives as well. Keep in mind that dividend hikes (or cuts) may greatly affect yields and scores.

Wrapping Up

The Chowder rule is a very handy tool to measure dividend yield combined with dividend growth. It is just one tool though. It may aide you in making investment decisions but it does not take the place of research. As shown in this article, you have to drill down and see why a company has the Chowder score that it does. You also must ascertain if a company can keep raising its dividend at an acceptable level.

You must consider a company's future prospects and not just its past. As the legal disclaimer goes, past results are not indicative of future results. Just because a company has a 25-year dividend raising record does not guarantee it will continue that path.

Yet, as Shakespeare was quoted, "What's past is prologue." Companies with a history of rewarding stock owners with dividend raises may be more prone to do so going forward. The key is navigating between both the past and the future when investing.

Sources: Seeking Alpha, YCharts, Fast Graphs, Yahoo Finance, Wikipedia, dividendinvestor.com, and, moneymorning.com.

Disclosure: I am long V, IBM, WMT, MCD, PG, INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: The Chowder Rule Shows The Best Dividend Growth Stocks Of The Dow Jones Industrials