I've previously written several sector specific articles to adjust dividend yields for risk and growth (Previous articles include oil and gas, dow jones components). Risk is quantified through the hurdle rate, based upon the stock's beta. Both articles provide a more detailed review of the methodology. The purpose of this article was to see the result of screening a full list of stocks for all three factors: dividend yield, risk, and growth.
Using the screening tools from Zacks.com, I filtered 922 stocks that showed dividend yields, positive historical dividend growth, and positive long term earnings per share growth. The stocks ranged from the familiar, Exxon Mobil Corp. (XOM), to less well known stocks, including Aixtron SE (AIXG). The top 15 yielding dividend stocks (and master limited partnerships or MLPs) from this list are below:
|1||American Capital Agency Corp.||AGNC||18.3%|
|2||Chimera Investment Corporation||CIM||16.0%|
|3||Annaly Capital Management Inc||NLY||14.3%|
|4||Cellcom Israel, Ltd.||CEL||14.2%|
|5||Hatteras Financial Corp||HTS||14.1%|
|6||World Wrestling Entertainment, Inc.||WWE||12.0%|
|7||Partner Communications Company Ltd.||PTNR||11.0%|
|8||Dynex Capital, Inc.||DX||10.4%|
|9||Telstra Corporation Limited.||TLSYY.PK||10.1%|
|10||Triangle Capital Corporation||TCAP||9.7%|
|11||Capital Product Partners L.P.||CPLP||9.6%|
|12||Navios Maritime Partners LP||NMM||9.5%|
|13||PennantPark Investment Corporation||PNNT||9.4%|
|14||Compass Diversified Holdings||CODI||9.2%|
|15||Ituran Location and Control Ltd.||ITRN||9.2%|
Data is from Zacks.com services downloaded on March 21, 2011. Data is from March 18, 2011.
This type of search is limited by the Zacks.com screening tools, and thus may result in the omission of several dividend yielding stocks. This screen also excluded negative beta stocks which can be valuable due to their diversification benefits. Some of these stocks have erratic dividend payments or are in general more questionable. I've ignited debates in other articles about ITRN and WWE. Personally, I am skeptical of both companies based dividend sustainability and irregular historical dividends. When I think about dividend investing, I try to minimize risk. Any red flag is often a decent reason to exclude it from consideration.
What I refer to as the DRG Score is simply rewriting the basic dividend discount model that balances the Forward Dividend Yield (DY) and Long Term Growth (G) against the Hurdle Rate (HR). The goal is to maximize DY+G-HR. If the formula holds, then this value is zero. A positive value represents potential upside and a negative value represents potential downside for the stock. Ranking the stocks according this formula produces very different results from the previous list based on dividend yields:
|Name||Ticker||Beta||Hurdle Rate||Forward Dividend Yield||LT Growth||DRG Score|
|United Microelectronics Corporation||UMC||1.1||9.9%||2.2%||81.4%||73.8%|
|Sony Corp Ord||SNE||1.4||11.9%||0.8%||77.0%||65.9%|
|Telecom Austria AG||TKAGY.PK||1.1||10.2%||5.2%||47.7%||42.7%|
|Validus Holdings, Ltd.||VR||0.3||5.4%||3.5%||41.6%||39.7%|
|NACCO Industries, Inc.||NC||2.3||17.4%||2.3%||51.7%||36.7%|
Data is provided by Zacks.com services. Hurdle rate assumes a 3.3% risk free rate and a 6.0% equity risk premium. Hurdle rate is calculated with the capital asset pricing model HR = Risk Free + beta x Equity Risk Premium.
So right now you are probably scratching your head and thinking that this is ridiculous. The DRG Score is completely skewed by earnings growth rates, which probably are not sustainable and will not result in comparable dividend growth over the long term. Many data sources show figures around 20% or 30% or higher -- this simply cannot be true in the long term. Looking at historical dividend growth rate also produces a top 10 list that looks equally unreasonable due to outliers with significant historical dividend growth rates.
What can be done about this problem? I decided to use the lower of the two growth rates. A key point is that the goal is to develop a simple mechanistic way to create a prospective list of dividend stocks. This means that we can miss some opportunities as long as we believe the list we produce has sufficiently good prospects. While not being perfect, this is a far better approach than individually assessing the growth prospects of all 1000 stocks each time you want to run a screen. This approach produces the following top list:
click to enlarge
Data is provided by Zacks.com services downloaded on March 21, 2011.
The first observation is that the 1-year dividend growth estimate (which is simply the five year historical dividend growth rate) is very high for most of these stocks. Note that the dividend discount model requires the forward dividend or yield, hence it is necessary to either screen for it or estimate it from the current yield. However, the key observation here is that the rank of these DRG Scores shows stocks without high dividend yields as noted in the ranking columns. For example, EOG Resources with a miniscule dividend yield (ranked 792) makes the ranking on the DRG Score (ranked 4) due to its high dividend growth rate. While this list might be an interesting starting point, it still seems like these stocks scored high due to recent growth anomalies rather than strong forward prospects. However, they offer intriguing prospects.
Picking 20 Stocks
So I screened the list with two additional criteria:
- Large market capitalizations (>$5 Billion)
- Reasonable current dividend yield (>3.0%).
The purpose of a list of dividend stocks is to produce current income. So the previously discussed EOG, while perhaps a good investment, is essentially a poor dividend stock. I also took the somewhat unusual step of capping the forward dividend yield at 10%. The DRG Score is correlated to forward dividend yield, which is highly influenced by a one year dividend growth rate assumed. This eliminated seven stocks: AGNC, CIM, CEL, PTNR, HTS, CTL, NMM, TLSYY.PK. I also eliminated stocks not traded on a U.S. exchange.
|Name||Ticker||Hurdle Rate||Dividend Yield||Forward Dividend Yield Estimate||Growth||DRG Score|
|El Paso Pipeline Partners LP||EPB||5.1%||5.0%||8.0%||6.5%||9.5%|
|Boardwalk Pipeline Partners L.P.||BWP||4.0%||6.6%||7.4%||4.5%||7.9%|
|Clorox Company (The)||CLX||5.8%||3.2%||3.7%||9.7%||7.6%|
|Philip Morris International Inc||PM||7.9%||4.2%||4.6%||10.6%||7.3%|
|Pacific Gas & Electric Co.||PCG||5.3%||4.2%||4.6%||7.7%||6.9%|
|General Mills, Inc.||GIS||4.6%||3.1%||3.4%||8.0%||6.8%|
|Wisconsin Energy Corporation||WEC||5.4%||3.5%||4.0%||8.0%||6.6%|
|Procter & Gamble Company (The)||PG||6.4%||3.2%||3.6%||9.4%||6.5%|
|Waste Management, Inc.||WM||7.1%||3.7%||4.1%||9.1%||6.1%|
Data is provided by Zacks.com services.
The first observation is that these stocks are still influenced by the estimated 1-year dividend growth rate. However, this list is also composed of more common names than previous lists in this article and includes a few MLPs. The next list highlights the difference between their dividend yield rank and their DRG Score rank. Some of the better stocks by the DRG Score do not necessarily have the highest dividend yields.
|Ticker||Market Cap ($ millions)||Dividend Yield Rank||DRG Score Rank|
Data is provided by Zacks.com services.
I think intuitively trying to balance risk and growth with dividend yields is a better strategy than just chasing yield. However, it probably works better with a more focused list of stocks. For example, an individual investor looking at utility stocks or oil and gas stocks could apply this methodology to screen within that sector. The final list of 20 stocks would be an excellent starting point for building a solid portfolio of dividend stocks.
These lists represent good starting points for investment analysis; however, it would be important to do additional research and analysis prior to making any investment decision.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.