Last August I bought 10 well respected dividend stocks. Two days later the market plunged and I realized I had to come up with a new approach to stock selection and timing, a better way of understanding what to look for to locate undervalued stocks and when to buy them. This worksheet is the culmination of that search and I've found it so useful I thought I'd pass it along.
After completing this checklist I know whether I want to buy a dividend stock now, or wait, and know exactly why I'm making this decision. I also have a much better grasp of the stocks I own and what to keep track of in the future.
Each heading or question has a blue link directly to the info needed. It may look confusing at first glance but only takes about 15 minutes per stock. Each step is explained below using Abbott Labs (ABT) as an example. You can view or download a copy in PDF here, or a working ODT copy here.
I mark each passing answer in green - each failing one in red.
Price to Owners Earnings - This is a gauge on how much cash per share there is after all expenses are paid. Less than 15 rates the stock a buy - 30 and above is a sell.
Scroll down the Key Ratios page to Free Cash Flow (I will refer to this as: FCF). Use the last numbers available in that row. Then find Shares Outstanding five rows above. FCF ÷ Shares Outstanding = the Owners Earning (OE) Per Share number. Then divide the share price by the OE.
For ABT I'm using the ttm (trailing twelve months) numbers and get OE of 4.845 ($7.631 billion dollars divided by 1.575 billion shares). Now divide the stock price by 4.845 and I get a number of 12.883. I enter that on the checklist. You can see the finished worksheet at the bottom of the page.
Here's a quote from the article by Peter Mycroft Psaras where I learned of OE:"... you will see that I have proven that anyone buying stocks selling for 15 times or less a company's price to levered free cash flow would have done very well over the last 60 years, putting up results close to what Warren Buffett has achieved, which is only logical as he is the creator of the Owner Earnings ratio..."
This number is the percent of Cash Flow going towards capital expenditures. It should be less than 50%. Go to Morningstar.com Key Ratios page and scroll down to Operating Cash Flow and Cap Spending. Divide Cap Spending by the number above it. I get 16.9%.
This simply tells you how much profit is in each dollar of capital invested. FCF is divided by Total Capitalization. Go to the Balance Sheet under the Company Profile at TheStreet.com and scroll down to Total Capitalization. This should be more than 15%. $7.631 FCF ÷ $36.48 billion Total Cap = 20.9%.
Return on Equity should be greater than 15% - ROE for Abbott is 20.1%.
Should be less than 50%. ABT's is 59% - I'll watch for that next year.
This measures the growth rate of an investment. Take the ROE number of 20.1% x (100 minus the Payout Ratio of 59% = 41%) which is a growth rate of: 20.1% x 41% = 8.24%. You want this above 15%. Article here for details.
This is an alternate to the payout ratio on how safe a dividend is. It shows how much FCF is used to pay dividends. Ideal is less than 50%. Scroll down to Payment of Cash Dividends at TheStreet.com under Cash Flow. This number is divided by FCF and gives me 38.5%. $2.94 billion in dividends paid ÷ $7.631 FCF = 38.5%.
H - Debt/Eq - copy this from the Company Profile page at TheStreet.com - we'd like to see this under 50%. Abbott's is 65%. I will watch out for deterioration in this number next year.
For the latest yield increase I go to Yahoo Finance. I get 3.26% for ABT. I want 3%+ on any dividend growth stock.
Four Year Dividend Growth Average - using the latest yearly dividend of $2.04 from Yahoo, go to Morningstar.com's - Key Ratio page and subtract the 2008 dividend of $1.41 which equals 63 cents. Divide that by $1.41 for a total four year 44.68% rise. Divide 44.68% by four years = 11.17% average growth per year. It should be greater than 8% per year with the Yield and Dividend Growth added together and totaling 10 or more. ABT's total is 14.37.
These are Yes / No questions. Go to Morningstar.com's Key Ratios page. Check each row of numbers for stability and growth for the past 10 years. Operating Margins have fallen for ABT from 20.3% to 14.8% last year - this rates a No. The rest are growing. Questions 1 - 11 by Adam Bauer here.
Check the share count for declining numbers. Abbott has had almost the same share count for the past 10 years.
Using the same Key Ratios page, Abbott passes these also.
Valuation - Is the present P/E is less than the 5 year average. ABT's is higher than the 5 year and rates a No.
Has this investment kept up with the market - I go to the Performance page and see that it beat the S&P by 19.18% in 2011. (This can be somewhat confusing - it lists how ABT did for the past 5 years, as well as year to date. It also lists the S&P. Two lines below that is: +/- S&P 500 TR - This line represents how ABT did in comparison to the S&P.)
I total five marks against ABT. This is within the parameters I use for putting new money to work, so I continue to the 5 year chart. I will wait and watch when a company has seven marks against it, or higher.
Before buying any company I check the 5 year chart with a 50 DMA & 100 DMA to see the direction it is heading. In most cases:
1) When the 50 day moving average is above the 100 day moving average, the underlying stock price tends to continue to go up consistently over time.
2) When the 50 day moving average drops below its 100 day moving average, the stock price tends to continue to go down consistently over time.
A buy signal is when the stock price is above the 50 and 100 DMA with the chart showing an upward bias.
A hold signal is given when the stock price breaks below its 50 DMA and/or 100 DMA. Wait for it to bottom and turn up before buying.
Here's the article on the 50/100 DMA in detail. As per the chart, ABT is passing this one also.
Abbott Labs certainly rates a buy with both the worksheet and the 5 year chart test. Since I purchased it in August of last year it is up 25.57%.
(click to enlarge)
Any errors or omissions in this article are solely the fault of this author.
Disclosure: I am long ABT.