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Potency Score System: The Best Dividend Growth Stocks For December 2011

The Potency Score System I introduced in October has come a long way from its original version. The objective of the System is to find the dividend growth stocks that have the best potential to not only sustain but grow their dividend regularly. These companies are bound to produce respectable capital gains as well. Using a multitude of fundamental data and metrics, the system calculates and assigns a Potency Score to each stock. The higher the score, the better the potential. I intend to publish the System's findings on a monthly basis.

This month's list of stocks with the highest Potency Scores (PS) is the product of the new Version 3.0.

I have also devised and published another well-received investment strategy, The Immortal Portfolio, for those who prefer a less hands-on approach, using Exchange Traded Funds (ETFs) instead of individual stocks.

New System Enhancements

The most significant enhancement to the methodology in the new version 3.0 is taking into account the inter-relation between the various metrics. One such critical interconnection is between Return on Equity (ROE) and Debt/Equity Ratio or leverage. ROE is a measure of profitability, or the rate of return to shareholders, and as such the higher it is, the better.

However, ROE can be artificially inflated by a company taking on more debt, i.e. increasing leverage. Being aware of the significance that investors put on the level of ROE, unfortunately some companies do in fact resort to less than desirable means such as taking additional debt when it may not be necessary or appropriate, to show a higher ROE. Another, and perhaps the ultimate example in this vein is when a company by means of creative accounting reports a respectable earnings per share growth rate (EPS) -- a highly followed metric -- while having a miserable cash flow. Unfortunately this is a fairly common practice.

Another improvement in this version is the ongoing fine tuning and refining of the various parameter weights and calculations. Empirical data as well as theoretical concepts are used for this purpose.

The Metrics

The Potency Score System (version 3.0) uses the following metrics:

1. Current Dividend Yield

2. Dividend Growth Rate (DGR) for 1-, 3-, 5-, and 10-year periods

3. The projected annual Earnings per Share (EPS) growth rate for the next five years

4. Payout Ratio

5. P/E Ratio (forward)

6. Return on Equity (ROE), 5-year average

7. Dividend to Free Cash Flow Ratio

Additional metrics are under study and examination and I will be introducing them into future versions of the System.

Sources of data - I have expanded my sources of data. The four DGRs for 1-, 3-, 5-, and 10-year periods and the $ dividend amount continue to come from David Fish's invaluable CCC List. The rest of the data come from various financial sources, including Fidelity Investments, TD Ameritrade, Google Finance, Yahoo Finance, Morningstar, etc. I have tried to use the most reliable sources, and where data was unavailable at one source I have tried to obtain it from another.

A Market Timing System Too?

I have been asked if the System produces the list of the best stocks, then how come it changes from month to month. The answer: actually the names on the list don't change much in short periods of time, barring any major changes in a company's fundamentals. However, the rankings do change. The main reason for that: price action.

With a company's fundamental metrics remaining roughly the same, as its price moves up and down, its Potency Score moves in the opposite direction. This means that the System does double-duty -- it not only brings forth the best dividend growers, but also flags the ones that have become cheap by moving them up the list, closer to the top. This implicit market timing feature is built-in and inherent to the System due to its methodology. So, yes, you can look at it as a market timing system in disguise!

The System for Shorter Horizons?

Another question I have been asked is about the suitability of applying the Potency Score if your time horizon is shorter than seven years. The answer is of course. The System identifies the stocks that are expected to perform well over the next seven years and beyond. This implies the stock is expected to do well over the next three-year, four-year, five-year, etc, periods. A stock can not perform well over the long term if it is not performing well incrementally. However, I caution against purchasing a stock, any stock, not just from the System's list, if your time horizon is less than 3-5 years. The market could go down and stay down for a decade or longer, and it has.

Let me end by sharing with you a piece of trivia before getting to the lists. The stock of Aaron's, Inc. (AAN), a specialty retailer, is the first alphabetically among the roughly 450 dividend growth stocks being followed, but it happens to be dead last when sorted by Potency Score, with a score of just 0.67. I found this to be an interesting coincidence. Now on to the lists:

Top Stocks For December

Data as of close Fri. 12/02/2011

Sym

Potency

Score

%Div

Yield

%

Norm-

alized

DGR

Price/

FCF

5 Yr Avg.

%Proj EPS Growth

5 Year

% ROE

5 Year

P/E

Forward

%

Payout Ratio

TTM

LMT

28.59

5.14

25.28

11.89

7.31

56.51

9.95

37.03

TEF

27.49

11.54

12.59

10.20

1.65

42.79

8.33

RCI

23.99

3.86

26.95

20.21

10.52

24.38

11.30

48.68

NPK

22.70

8.84

13.70

-33.81

15.28

12.12

TGH

20.44

5.39

19.49

12.00

21.41

7.01

34.26

STRA

20.31

4.07

23.63

31.68

10.39

48.39

13.99

42.79

AZN

19.37

5.97

17.16

10.20

-0.68

39.32

37.21

TWGP

18.34

3.58

24.02

17.00

17.05

7.49

30.79

MO

17.91

5.77

16.51

14.74

8.00

57.79

12.97

92.55

ACI

17.71

2.72

27.70

5.84

34.65

12.75

6.06

57.77

TCAP

17.20

10.13

7.63

4.00

7.96

8.76

58.71

RTN

16.80

3.79

21.83

15.20

7.20

17.66

8.58

32.82

GES

16.78

2.83

26.24

24.57

14.50

29.47

7.55

25.36

HRS

16.20

3.12

24.23

16.82

7.67

20.55

6.52

23.45

DRI

16.12

3.62

26.31

17.33

12.80

24.03

11.07

40.97

UNS

15.93

4.63

18.07

12.99

3.00

10.02

13.37

54.61

NVS

15.71

4.40

18.62

13.56

5.70

18.83

9.52

46.72

ACN

15.57

2.31

28.19

12.90

12.40

65.00

13.68

26.47

BBL

15.27

3.27

22.63

15.62

9.10

36.75

21.32

HAS

15.22

3.33

22.31

19.24

10.00

21.78

10.87

39.61

EOC

15.18

4.56

17.56

15.86

18.92

12.12

INFY

14.58

2.56

25.65

35.81

16.86

32.06

16.23

23.29

NTT

14.48

2.95

23.38

8.00

6.54

7.16

8.17

14.86

WSO

14.34

3.94

18.91

14.51

17.62

11.49

20.00

76.51

PNNT

14.29

10.48

4.46

4.00

-0.37

8.28

445.83

INTC

13.76

3.41

20.44

17.60

12.00

16.06

9.58

31.59

KOF

13.03

2.28

25.71

16.46

13.27

13.50

15.65

YUM

12.95

2.03

27.39

24.80

12.08

127.46

17.61

39.17

SJR

12.88

4.58

14.91

22.78

0.00

22.14

11.48

72.85

CL

12.76

2.57

23.67

21.37

8.90

99.72

16.31

44.57

-

Top Popular Stocks For December

Sym

Potency

Score

%Div

Yield

%

Norm-

alized

DGR

Price/

FCF

5 Yr Avg.

%Proj EPS Growth

5 Year

% ROE

5 Year

P/E

Forward

%

Payout Ratio

TTM

MCD

12.08

2.93

20.78

20.52

10.05

27.31

16.75

47.88

JNJ

9.96

3.59

14.84

14.52

6.14

27.13

12.14

54.12

ABT

9.57

3.55

14.43

16.11

9.19

22.27

10.74

63.16

PEP

9.56

3.20

15.93

22.77

7.95

36.36

13.87

49.89

KMB

9.35

3.96

12.47

15.90

6.75

33.64

13.50

65.89

WMT

9.29

2.51

19.12

29.93

10.98

21.02

11.82

30.20

GIS

9.24

3.05

16.14

17.98

7.33

25.10

14.10

43.87

K

9.19

3.50

14.03

22.91

8.13

54.68

13.87

50.68

PG

8.98

3.25

14.80

18.96

9.00

18.64

14.12

51.15

COP

8.71

3.64

12.67

22.69

4.25

7.77

8.72

32.48

KO

7.71

2.83

14.56

22.44

7.14

32.29

15.95

34.01

T

7.40

5.94

3.15

13.73

2.75

12.48

11.64

87.37

MMM

6.88

2.76

13.28

17.39

11.22

33.02

12.61

36.99

VFC

6.21

2.08

15.94

13.65

11.57

15.83

14.66

40.68

CVX

5.75

3.19

8.51

-50.45

3.10

22.38

7.81

22.24

APD

4.32

2.83

6.09

92.46

8.12

18.30

12.11

39.89

Source: Potency Score System: Best Dividend Growth Stocks For December