A Revised Approach To Retiring With A Decent Dividend Income

by: California Dividend Bull

About five months ago I published my first article here on SA by laying out the path I had chosen to find securities worth to be added to my wife's and my retirement accounts. The article can be reviewed here.

In a nutshell my workflow looked like this:

  1. download a fresh copy of David Fish's CCC list after the last trading day of every month
  2. trim the "All CCC" sheet from all companies having raised their dividend payouts for less than nine years
  3. eliminate all firms with negative earnings during the trailing twelve months and dividend payout ratios over 99% of earnings
  4. take a couple of numbers from the list, add a yield-on-cost formula to determine where I'd be with any stock on the list five years from now and weigh everything against each other

Of course there wouldn't be much sense in setting up this new article with the subject "A revised approach" if there wouldn't have been any changes to that procedure. Over time I have seen that some metrics are less meaningful to me while others have become more important than they were a year ago. After all, we're talking about a learning curve while setting up a basket of stocks which are supposed to be held to eternity and supply us with an income that outperforms inflation by a wide margin. So what is it what is more important to me right now compared to half a year ago? Well let's get into it then.

I still rely on David Fish's list which is updated monthly. I also still exclude every company which has not increased their dividend payouts for at least nine consecutive years. This is important to me because this time frame typically includes at least one full business cycle and one medium to large market correction. I further eliminate all Master Limited Partnerships (MLP's) because of their (at least to me) eludingly complex tax structure. I have read on several investing websites that these partnerships are not a good idea to be held in tax-free accounts like my Roth IRA so I simply don't want anything to do with them, period.

Next thing on my to-do-list is getting the current annual dividend, the expected five year growth, the annualized dividend growth rate for the last 1-year, 3-year and 5-year periods and the confidence factor from the list. I still consider this number the single most important piece of information put together by David since it includes so many metrics about any given stock. Everything under 50 will be eliminated, although my final screening list usually only shows figures way above the 60 mark.

This concludes the numbers I am taking from the given set of information. When the remaining ticker symbols are copied to my Google spreadsheet, I can go ahead and add the three remaining figures. Any stock's EPS, current price and 52-week-high are being imported automatically via Google's finance function. Other figures like current entry yield and current P/E ratio can easily be calculated with these numbers. Dividend payouts above 99% of earnings are being slashed from the list with no mercy. I'm looking for long term prospects and can't get to like companies like AT&T (NYSE:T) in my portfolio which pay out way more dividends than they actually produce in free cash. The same fate applies to managements who weren't able to generate at least $1 per share in earnings for the last 12 months.

I used to automatically delete every stock with a P/E ratio above 20 but now I have upped this threshold to 25. Why? Because I realized that a PE of 18 may be high for one stock but 22 may be low for another. I want to own high quality stocks with the potential to be held in my possession as long as I live, and beyond. Why be penny-wise and pound-foolish...

Companies like Coca-Cola (NYSE:KO) come to mind. The soda distributor has had PE ratios above 20 for about 50% of the time over the last ten years. Nobody will doubt that it is a very solid corporation churning out huge shareholder returns and increasing the free cash-flow almost every single year. The same goes for Procter & Gamble (NYSE:PG) which has had 20+ earnings multiples for 70% of the same time frame or Walgreen (WAG) with half the time being over the magical 20 mark. Why should I bother overpaying a few dollars today when I expect the stock to reward me greatly over the next decades I intend to own it.

A metric I have built in now which wasn't there before is every stock's range from its 52-week-high expressed as a percentage. This is my way of finding bargains on beat-down stock prices. My favorite subject on this matter is currently Target (NYSE:TGT). Everybody is firing upon the retail giant because of supposed problems with the holiday shopping and the issues in Canada. Target has increased shareholder returns for 46 years in a row. This is going back eight years before I was actually born. So why should I be concerned about a few bumps on the road to my financial independence. I'll just collect the deposits to my account every ninety days, buy up more shares for a bargain price and watch Target slowly take over a part of the Canadian retail landscape which will eventually further increase my quarterly dividend.

So after eliminating all candidates which do not fit my requirements, in the end there's one final step: weighing my four most important metrics and boil the list of prospective investments down to a manageable handful of stock I want to look into a little deeper. Therefore I'll sort and rank the list by

  1. years of consecutive dividend increases
  2. confidence factor
  3. distance from 52-week-high and
  4. yield-on-cost after five years (based on current entry yield and the lowest number of the stock's annualized 1-year, 3 year or 5-year past)

As of today my top 5 stocks to look at would be Target, Walgreen, McDonald's (NYSE:MCD), ConocoPhilips (NYSE:COP) and IBM (NYSE:IBM). Since I already own quite large positions in Target and McDonald's, with my next fresh capital I would go out and have a deeper look at Walgreen. I owned this stock for a brief time last year but unfortunately sold the positions to take a 33% profit. Today I consider myself a wiser and more mature dividend growth investor and would not sell such a fine company that easily anymore. My holdings of AFLAC (NYSE:AFL), Lockheed-Martin (NYSE:LMT) and Medtronic (NYSE:MDT) have performed so well that they all currently stand at a 50+% profit. Nevertheless I will not even consider selling them since they are wonderful cash cows padding our accounts with fresh capital like clockwork every ninety days.

Disclosure: I am long AFL, LMT, MCD, TGT, MDT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.