Total Dividend Return is an important metric to consider when adding new positions.
Additionally, there are several other metrics that should also be considered, including earnings and dividend growth.
Here is a step-by-step look at the process I use to choose stock candidates for my portfolio.
I'm retired and in the Distribution Phrase of Investing. I have a business plan for my portfolio that requires an end of the year assessment with a definition of my goals and focus for the year ahead. In Part One, I discussed an important part of that assessment and my shift this year from building income from yield to Total Dividend Return (TDR). In Part Two, I hope to further clarify this shift. Specifically, I want to show how I hope this important metric will help increase the overall dividend growth, and ultimately the income generated by my portfolio during 2014.
A quick recap for those unfamiliar with TDR. In many articles on Dividend Growth, TDR is commonly referred to as the "chowder rule" in honor of chowder, a regular contributor here on Seeking Alpha. Under this rule, a stock yielding 4% along with a 5 year Dividend Growth Rate of 8% would produce a total dividend return of 12%. A stock yielding 3% would require higher dividend growth to produce a TDR of 12%. The rule is relaxed a bit for higher yielding/slower growing equities such as utilities, telecoms and mlps. With this group, a total dividend return of 8% is sought.
This time around, I thought it might be helpful to take you through the process of how I will personally select new stock positions during the up-coming year.
I'm a Dividend Growth Investor and I expect all of my new positions will be Dividend Champions, Contenders, Challengers (CCC) and Near Challengers. As of the end of January, there were 488 CCC listed stocks available here. Since my focus is on income, I plan to pay the most attention to those CCC stocks that yield 2.75% or higher. Stocks yielding between 2.5% and 2.75% are within my range for future consideration and could be included in my watch list.
There were 259 CCC stocks yielding 2.5% or better as of January 31st. For this group, the average 5 year projected earnings growth was 6.3%. The group enjoyed a 1 year Dividend Growth Rate (DGR) of 8.7% and a 5 year Dividend Growth Rate (DGR) of 8.5%. The average yield for the group was 3.85%.
The next step in my evaluation was to determine how many of these 259 stocks qualify under the TDR/chowder rule metric. While the group enjoyed a combined chowder score of 12.4, more than 100 of the total failed to individually qualify.
I eliminated those, and I discovered an increase in not only the combined chowder rule score, but four additional metrics that I always consider when making a selection to consider adding to my portfolio:
· 5 year Estimated Earnings Growth
· 5 year Dividend Growth Rate
· 3 year Dividend Growth Rate
· 1 year Dividend Growth Rate
The 157 stocks making the cut have a combined chowder rule score of 15.5. In addition, the average yield increases to 4.12%. The group has estimated 5 year earnings growth of 7.2. Its 1 year Dividend Growth Rate is 11.0 with 5 year DGR of 11.4. Between my wife and I, we own 52 of these, leaving just over 100 for further consideration.
For me, the next stop is always the Morningstar website to conduct a 10 year Performance Review looking at performance year by year. Personally, I purchase few stocks for our portfolio with a history that doesn't reach back to at least 2008. The reason is simple. First and foremost, I want ownership in companies that handled the worst of times and actually grew their dividend. I also prefer those companies that sustained losses less than the market during that turbulent period.
Since capital preservation is important, I also prefer stocks with no more than three down years during a ten year period.
For me, the next step is to review my portfolio sector distribution. I am currently light in Consumer Discretionary, Technology, Banks, Industrials and Materials. All else being equal, candidates in those sectors would likely be given preference during selection.
The next step is to determine value and I use two sites to do just that: FastGraphs and Morningstar. I prefer my limited new purchases to be undervalued.
Next, it's back to Morningstar to see if any of the candidates qualify under their quality credit rankings. We currently own 41 companies that qualify for that distinction.
Then its back to the remaining candidates for final consideration of Dividend Growth rate and 5 year Estimated Earnings Growth. I consider earning growth to be important. In my opinion, a company with a history of dividend increases is more likely following growth to rewarding its shareholders by a growth in the dividend.
Finally I look at one, three and five year dividend growth rates. Personally, I again prefer those where dividend growth is increasing. Consistency within each rate is also something I look for.
There you have it. My step by step process for finding those candidates for a position in our portfolio.
For those interested in learning more about TDR a/k/a the chowder rule, click here for a discussion from its originator chowder.
As always, I value your comments and questions. I would love to learn what additional measures you consider when you consider a new candidate for your portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.