Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Dividend Growth - The Stock Selection

My primary objective for investing is to seek income replacement. I want to earn more income from my investments than the income I earned during my working years.

I believe the best way to achieve that is through Dividend Growth Investing.

Dividend growth is the critical piece in the puzzle for creating a portfolio that will serve you over the years. ... Please pay attention!

This is a simple idea, but it is also the single most important idea for long term investors. The reason it is so important is that "dividend growth drives the compounding principle" for individual stocks in a way that is certain and inevitable. It is an authoritative force that compels higher returns regardless of the other factors affecting the stock market.

Let me repeat that! ... "Dividend growth drives the compounding principle."

The important point is that an instrument that produces income is valued based on the amount of income it produces. And, the more income it produces, the more it is worth.

This instablog is going to delve into the selection process for companies that support my objectives.

In sales, in sports, in investing or anything else in life, it all starts with the basics, the fundamentals. When you understand the basics and fundamentals of an activity, you have something to build on.

There are times in life where you will face adversity in anything you do. The way you usually get back on track is to go back to the basics and start all over again. My goal is to stick with the basics and minimize the adversity I face moving forward.

So here's the success formula that never fails:

High Quality + High Current Yield + High Growth Of Yield = High Total Return.

This formula never fails. You may fail the formula, but the formula won't fail you.

Here are the components of High Quality. High quality companies are financially strong and are signaled by low debt, strong cash flow and overall creditworthiness. Financial strength is the key requirement in the stock selection process. Since we are buying ownership in a business, a business is a financial entity. Therefore, if a company doesn't meet my safety ratings, the due diligence process goes no further. It's what I look at first.

If one were to look at a Value Line Survey, I require a 1 or 2 rating for safety. The VL financial rating must be B+ or better. If you are looking at an S&P rating, it must rate BBB+ or better.

Financial safety is job #1.

Once the safety rating is satisfied, then earnings is the next step. Earnings is the oil that keeps the dividend growth machine running. I look to see that earnings have risen at least 7 out of the last 10 years.

I then look for revenues and cash flows to have increased 7 out of the last 10 years.

Once this criteria is met, the dividend is next. I want to see the dividend raised in 10 out of the last 10 years. This covers two recessions and I want to insure that my companies were able to continue raising my income regardless of economic conditions.

At this point you may choose your other criteria such as minimum yield requirement, beta, return on equity, price earnings ratio, payout ratio or any other criteria you deem important. My point is that those fundamentals don't even get looked at until the financial safety, financial rating, earnings, revenue and cash flow requirements are met.

When all of this is complete, I then apply my Chowder Rule.

My objective is to grow my portfolio at an 8% total return, compounded annually. I'm not opposed to higher than that, it's just that in order to get the end result, that's what it will take.

I decided that as a dividend growth investor, I wanted the dividend and the dividend growth to take pressure off of the share price in the total return equation. I can control the dividend I take on, and I can control the companies I add via dividend growth. I have no control over share price. So, it made sense to me to focus on what I could control.

Since 8% is my total return number, I wanted to buy companies that when you combined the current yield with the 5 year compounded annual growth rate (OTCPK:CAGR), I wanted it to equal 12% or more, giving me a buffer or dividend moat against my total return objective.

In other words, if the yield is 3% I want a 5 year CAGR of 9%. If the yield is 4%, I want a 5 year CAGR of 8%. This is of course after all other fundamental criteria has been satisfied.

I was willing to lower the Chowder Rule for utilities, MLP's and REIT's because of the nature of how they conduct business. They all have long term contracts that guarantee revenue. Therefore, I believed the dividend and dividend growth are more reliable. That reliability stills meets my 8% goal.

Others can adjust it to meet their total return number. The 8% is not written in stone.

There you have it. That's the process I use when making selections for my dividend growth portfolio.

These concepts and principles are illustrated in the book, "The Single Best Investment" by Lowell Miller. I highly recommend it.

In closing, I'll recite the "Warrior Code" as discussed in the book above.

The hard part in investing is holding, and learning to tolerate the myriad and relentless swings of greed and fear to which an investment holder is inevitably subject. Unless you control these impulses, and we all have them, you won't reach your ultimate goal.

Holding successfully requires a kind of spartan attitude, a kind of warrior attitude, in which you hold your ground, never retreating, through thick and thin, storms and sun, excitement or depression.

The warrior attitude says: this is my strategy, it is a good one, it will work; I will not deviate from it no matter what, as long as the position continues to meet the success formula that never fails.

High Quality + High Current Yield + High Growth Of Yield = High Total Return.

Dividend growth drives the compounding principle!