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David Crosetti
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I was born and raised in California. I worked in the family business for a number of years and then decided to spread my wings and try working for someone else. My first significant job was with Frito Lay. After a stint in the salty snack business, I transitioned to the beverage industry,... More
  • 10 Commandments for Dividend Growth Investors--Part 2 Breaking (Down) the Commandments 6 comments
    Sep 23, 2011 10:19 AM | about stocks: INTC, JNJ, MCD, CTL, KO
    In my first article:  10 Commandments for Dividend Growth Investors, I presented you some "rules" in regard to the concept and strategy of Dividend Growth Investing. 

    One of comment that came up time and time again was, "How do I find companies to invest in and how to I value those companies in order to make a good selection."

    The first four Commandments go hand-in-hand with one another.  In my opinion, these four Commandments are the cornerstone for DG investors.  A company that does not meet these four Commandments does not qualify as a DG stock.  Plain and simple.  That company would fit nicely, perhaps in a different investing strategy, but not in this one--again, in my opinion.  Let's recap again:

    1.  Thou shall seek and identify companies that have a commitment to paying dividends---and have done so for long periods of time.

    2.  Thou shall invest in companies that have increased their dividends annually and have done so consistently.

    3.  Thou shall invest in companies that have a low payout ratio for those earnings, related to their earnings.

    4.  Thou shall invest in companies that can sustain those dividends by having the earnings growth to continue paying them.

    So where do we begin our seach for companies?  There are many places you could go and look up one company at a time.  But, David Fish has produced a list of what he calls Dividend Champions, Contenders, and Challengers.  Here is a link to David's site:

    http://dripinvesting.org/Tools/Tools.asp

    This list not only provides the names of companies that have a commitment to paying dividends, but also has information that is updated monthly, such as  the industry the company is in, the years they have paid dividends, the dividend amount, the dividend growth rate, the payout ratio, the other fundamentals such as PE, PEG, Standard Deviation numbers, etc. 

    There aren't many sites on the internet that are this detailed and as full of information as this one.  If you do not have it among your favorites, then you are really missing out on an incredible tool.  I cannot encourage you strongly enough to make this site a place you go to month after month.

    The question that you must ask at this point is:  "Can I be a successful dividend growth investor by just selecting companies that make up the CCC lists?"  The short answer is "no."

    Moving Forward:  Find a good screening tool.

    Just because a company is listed as a Dividend Champion, Challenger, or Contender does not mean that it is automatically a "must have" position for your portfolio.  Random Walks Down Wall Street are ok for tourists, but not for you and me.

    Define how you are going to value a company.  Everyone has their key metrics for stock selection.  For me, I want to begin with the CCC list and then break that down to companies with the best results against my personal metrics.  By using the CCC list, I already have a list of the companies that meet the requirements stated in the first 4 Commandments.  Now, I need to look for individual targets for possible addition to my portfolio.

    The best way to put together a snapshot of the metrics that you will use to value your stock selections is through a Stock Screener.  I use Charles Schwab as my brokerage and they have a good screening tool.  I am sure that the other brokerage houses have similar, and perhaps better screening tools.  In this computer age, having screens available makes the job so much faster, it doesn't make sense to not use one.  Here's what I look for:

    1.  Dividend Yield:  This is the relationship between the actual dividend paid and the current price of the stock.  Since the price of the stock changes daily, the dividend yield is changing as well.  Consider INTC for a moment.  The company pays a dividend of .84 a share.  A current price for the stock was $22.16 per share.  That would indicate a dividend yield of 3.79%.

    2Dividend Payout Ratio:  This is the relationship between the dividend paid and the company's earnings per share.  For example, a company like KO has a dividend payout ratio of 35%.  MCD has a dividend payout ratio of 56%.  CTL has a dividend payout ratio of 132%.  The importance of this metric is that it forces you to ask about Commandment 4--is the dividend sustainable when a company is paying 132% of EPS as their dividend?

    3.  Dividend Growth Rate:  As dividend investors, we want to know how fast the company is growing it's dividend.  A company that  is growing its dividend by 10% a year will double its dividend payment in 7 years.  A company that is growing its dividend by 6% a year will double that dividend in 12 years.  I like to look at 5 and 10 year dividend growth rates.  JNJ has a 5 year dividend growth rate of 10.6% and a 10 year growth rate of 13%.  Putting that into perspective, in 1999 JNJ paid a dividend of .5450 per share.  That means that if you owned 100 shares of JNJ, you would receive $54.50 in annual income.  But, today, JNJ pays a dividend of $2.28 per share.  Those same 100 shares are now paying you $228.00 in annual income.

    4.  PE Ratio:  This is a relationship between the current price of a stock and its earnings.  Why is it important?  For all practical purposes, the PE ratio is showing you how much you will be paying for every dollar of earnings.  If a company has a PE of 20, you are paying $20 for every dollar of earnings that the company throws off.  When someone says that 10 or 20 years ago, a particular stock was "overpriced" they are referring to the PE ratio relative to its historical average. 

    5.  PEG ratio (Price to earnings growth ratio)
    – This ratio is closely related to the first ratio, but it is slightly more dynamic and incorporates the estimated growth of a company. In the PEG ratio the formula uses the price/earnings ratio and then divides that number by the expected annual earnings per share growth rate. This is a great valuation method to use when considering whether a stock that is growing quickly is still a good value or not, but the method is also subject to objective guesses as to the growth rate.

    6.  Earnings Per Share: Not only do I want to know how much the company is earning per share, currently, I also want to know what the earnings estimates are for next year.  A  metric that I like shows trailing EPS growth and rolling EPS growth.  

    7.  Price/cash flow ratio – This method measures the ability of a company to provide cash flow on a per share basis. The ratio is calculated by taking the stock price per share and dividing that by the operating cash flow per share. A top reason to use this method is it typically excludes possible accounting distortions that other investment ratios might not be able to exclude.

    8.  ROE:  One of the most important profitability metrics is return on equity (or ROE for short). Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet.
    Shareholder equity is total assets minus total liabilities.  I like to look at an ROE greater  than 15%.

    9. Debt to Equity:  The Debt to Equity Ratio measures how much money a company should safely be able to borrow over long periods of time. It does this by comparing the company's total debt (including short term and long term obligations) and dividing it by the amount of shareholder equity.  The lower the Debt to Equity ratio the better.

    Conclusion

    Dividend Growth Investing is not a "get rich quick" proposition.  You cannot simply select stocks that have paid dividends for a long period of time, purchase them randomly, and expect to have good results.

    There seems to be some confusion about the strategies behind DG investing by people who don't practice this particular investment style.  When you read criticisms of DGI, you will often see this strategy being completely misunderstood.  The reason, is because there are "rules" to this strategy that a lot of people just don't understand.

    One of the most misunderstood rules is the rule of selling a stock when it cuts or suspends its dividend.  For me, this is an absolute rule.  I don't question it, I don't rationalize it, I just go ahead and sell my position.  Most recently BAC fell under this rule.  The company announced that they would be cutting the dividend in half.  I sold my position that afternoon.  Plain and simple.

    Dividend Growth Investing is one style/investing concept.  There are many.  Each has its strengths and each has its weaknesses.  To say that one is "better" than another is foolish.  I guess an analogy is avocados.  For some people they are an acquired taste.  You either love them or you don't.  But, I'll tell you something about avocados that  you might not know.  If you put one in front of a dog, he will eat that avocado faster than he'll eat a slice of a ribeye steak.  Now, avocados are not good for dogs and I don't recommend that you feed one to your dog.  But having lived in Florida and seeing what dogs can do to avocados, I speak from first hand experience.

    Hopefully we will have more to follow in this series of the 10 Commandments of Dividend Growth Investing.

    God Bless.

    Dave





     
     


    Disclosure: I am long KO, JNJ, MCD, INTC.
    Stocks: INTC, JNJ, MCD, CTL, KO
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Comments (6)
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  • David Fish
    , contributor
    Comments (9280) | Send Message
     
    DC,
    Great follow-up to your initial article; I'm not sure why SA didn't publish this (yet) as it certainly is better than many of the articles they have published!
    Near the end, you mention the BAC dividend cut (and your sale). Does this mean that you haven't had to sell any positions since 2008/9?
    26 Sep 2011, 12:31 PM Reply Like
  • David Crosetti
    , contributor
    Comments (13528) | Send Message
     
    Author’s reply » They said it was too much like my first article (rehashing the same stuff) and that most DG investors already are aware of these metrics. Here's the deal. My first article, which was really quite basic, had 18,300 page hits. It has me ranked 23rd in "Dividend Investing Ideas." But to carry on a stream of thought on the Commandments was to light for SA. I guess I will write an article on why KO is a stock for the future, cut an past it from Argus Research and generate 100 page views and have 4 comments. That's the type of article that seems to get their attention.

     

    Or 10 DIvidend stocks that are primed to pop! From the comments on my first article and the thngs I read on other articles, there is a universe of people out there that are looking for advice, they are looking for a venue to confirm their own thought process, or they have absolutely no clue as to what to do with their investments other than buy mutual funds.

     

    There is an untapped group of "newbies" out there that are going to get plucked like Christmas turkeys. I used to be one of them.

     

    Dave
    26 Sep 2011, 05:05 PM Reply Like
  • David Fish
    , contributor
    Comments (9280) | Send Message
     
    Well, congrats on the 18,300 pageviews. I've only had a few like that (out of 90+ articles) so you did really well out of the gate!

     

    You're right, though, it takes some effort getting used to what SA wants. It seems to help to at least name a few stocks and having a number in the title seems to help, also.

     

    Try not to get discouraged...keep plugging away!
    26 Sep 2011, 05:18 PM Reply Like
  • David Crosetti
    , contributor
    Comments (13528) | Send Message
     
    Author’s reply » David: I have not "had" to sell any of my positions since 2008. I did sell some MCD this year, to have money to buy INTC, MSFT, and WM. I also sold a little KO to build my cash on hand for other opportunities. My last purchase was an additional stake in T at $27.36
    with a 6.25% yield.

     

    My portfolio has ABT, MO, T, KO, CL, XOM, JNJ, KMB, MCD, PG, WMT, CVX, COP, INTC, MSFT, PCG, PEG, RAI, VZ, WM. These are my CCC holdings. I also own PFE, DD, BMY, EXE, and GE as non CCC companies.

     

    My next attempt at an ariticle will focus on the 5th Commandment, which is DG Investors should not chase yields. I eliminate any reference to the 10 Commandments and focus on companies that pay large yields, but are companies that I think should be avoided as there are better places to put your money.

     

    Let's see if this one gets any hits from the editors at SA.

     

    Dave
    26 Sep 2011, 05:52 PM Reply Like
  • David Fish
    , contributor
    Comments (9280) | Send Message
     
    Good luck...it sounds like it'll be of interest to a lot of people!
    26 Sep 2011, 07:48 PM Reply Like
  • Berninvestor
    , contributor
    Comments (945) | Send Message
     
    Dave,
    Of course I totally agree with the comment by David Fish: "I'm not sure why SA didn't publish this (yet) as it certainly is better than many of the articles they have published!" I think your detailed explanations are very helpful to newbies as well as oldbies and worth saving for future reference. Don't get discouraged. Remember what I told to about persistence!
    27 Sep 2011, 11:00 AM Reply Like
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