DivGro Stocks Ranked By Quality Score

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Includes: ABBV, ADP, AFL, AMGN, AVGO, BA, BLK, CL, CMCSA, CMI, COST, CVX, DGX, EMR, FDX, GD, GILD, IBM, INTC, JNJ, LLY, LOW, MA, MAIN, MDT, MMM, MO, MRK, MSFT, NKE, NNN, ORCL, PFE, PG, PM, RTN, SPG, SYK, T, TROW, UNH, UPS, UTX, V, VLO, VZ, WFC, WMT, XOM
by: FerdiS
Summary

My DivGro Pulse articles focus on the strategy of dividend growth investing.

This month, I'm focusing on the quality of my holdings. Specifically, I rank my dividend growth stocks by quality score.

I think targeting high-quality stocks available at discounted prices is a good way to deploy available capital.

My DivGro Pulse articles focus on the strategy of dividend growth [DG] investment.

Generally, I want to buy the highest quality DG stocks at the deepest possible discounts. Ideally, those stocks would offer the highest dividend yields and double-digit percentage dividend growth rates. I would prefer a fully-diversified and equally-weighted portfolio with very little risk and exceptional, market-beating returns.

If only all of this were possible!

As DG investors, we have to choose among several attractive and mostly competing objectives. Higher yields usually mean more risk and slower growth. Higher quality rarely is deeply discounted, and increasing diversity reduces the likelihood of market-beating returns.

How DG investors choose to balance these aspects depends upon their portfolio's function and their personal goals. In sharing my approach, I hope to inspire readers to think about their own approach and strategy, and to share ideas so we can all learn from each other.

Quality is This Month's Focus

For this month's pulse article, I decided to rank the dividend growth [DG] stocks in my DivGro portfolio by quality score. I've been inspired by David Van Knapp's quality scoring system presented in this article on high-quality, high yield DG stocks.

I started using quality scores in my articles on the top holdings of dividend ETFs (here and here) and found a positive correlation between quality scores and my ranking of these holdings. In more recent articles, I used a modified version of the quality scoring system to rank the Dividend Aristocrats, the Dividend Kings, and high-yielding, high-quality DG stocks.

I love the simplicity of the quality scoring system and it appears to do a remarkable job identifying high-quality stocks.

By ranking the DG stocks in my portfolio by quality score, I'm able to identify and potentially close weaker positions. Doing so should help me to continue to improve DivGro's risk profile.

Additionally, by targeting high-quality stocks available at discounted prices, I can increase my chances of earning market-beating returns. And adding to small positions in my portfolio will improve the overall balance of my portfolio.

Quality Scoring System

The quality scoring system employs five widely used quality indicators from independent sources and assigns 0-5 points to each quality indicator, for a maximum of 25 points. I call the total score a stock's quality score.

Here are the quality indicators used in determining a stock's quality score:

You can read about these quality indicators by following the provided links.

Here is the scoring system and the color-coding scheme used in determining quality scores:

Modified versions of David Van Knapp's quality scoring system and color-coding scheme.

My modifications include assigning 3 points to companies that don't have an S&P Credit Rating but carry no debt. In order to rank DG stocks, I break ties by considering the following factors, in turn:

  • Dividend Safety Score
  • S&P Credit Rating
  • Dividend Yield

I use a similar color-coding scheme than in the original article, though I differentiate perfect scores.

Key Metrics and Fair Value Estimates

In addition to quality indicators and quality scores, I provide columns with key metrics of interest to DG investors, including years of consecutive dividend increases (Yrs), the dividend Yield for a recent Price, and 5-year compound annual dividend growth rate (5-Yr DGR).

Furthermore, I provide a fair value estimate (Fair Val.) to help identify stocks that trade at favorable valuations. The last column shows the discount (Disc.) or premium (Prem.) of the recent price to the fair value estimate.

To estimate fair value, I reference fair value estimates and price targets from several sources:

  • Morningstar: fair value estimate based on discounted cash flow analysis
  • Finbox.io: fair value estimate based on several financial models
  • Finbox.io: the average of analyst targets
  • Value Line: the average of VL's target range

Additionally, I estimate fair value using the 5-year average dividend yield of each stock using data from Simply Safe Dividends:

fair value estimate = recent price × dividend yield ÷ 5-year average dividend yield

With five estimates and targets available, I ignore the outliers (the lowest and highest values) and use the average of the median and mean of the remaining values as my fair value estimate.

DivGro Stocks with Perfect Quality Scores

The top-ranked stocks in my portfolio are Johnson & Johnson (JNJ), Microsoft (MSFT), Merck (MRK), Procter & Gamble (PG), Visa (V), and Automatic Data Processing (ADP), all earning perfect scores of 25.

JNJ and MRK are trading below fair value, so now may be a good time to add shares. In particular, my MRK position is only about 0.3% of total portfolio value, whereas my average position size is about 1.15% of total portfolio value. To match my current average position size, I would need to add 80 shares of MRK.

My JNJ position is an above-average size position, so I'm not interested in adding shares at this time.

There are only two other DG stocks in the CCC spreadsheet that have perfect quality scores: Oracle (ORCL) and Nike (NKE). I don't own either of these stocks. Both are trading at premium prices, but I've sold put options on both in an attempt to open positions at more favorable levels:

  • ORCL 20SEP19 55.0 P
  • NKE 18OCT19 75.0 P

I sell put options on DG stocks I'd like to own when those stocks are trading above the price I'm willing to pay. So I'm willing to buy ORCL for $55 per share on or before 20 September, and NKE for $75 per share on or before 18 October. For reference, ORCL is trading above $58 and NKE is trading above $87 per share.

DivGro Stocks with a Quality Score of 24

The stocks in the second group missed a perfect score on only one of the quality indicators. There are 24 DG stocks in the CCC spreadsheet with a quality score of 24. I own 19 of these stocks:

Several stocks are trading below fair value and are good candidates for additional investment. However, I would prefer targeting relatively smaller positions, as this would improve the distribution of position sizes (weights) of stocks in my portfolio.

Company (Ticker)

Current

Weight

Needed to reach

average position size

(1.15%)

Note

Raytheon (RTN)

0.55%

27 shares

+26 shares to 50 shares

UnitedHealth (UNH)

1.20%

Medtronic (MDT)

0.61%

46 shares

+50 shares to 100 shares

Boeing (BA)

0.83%

8 shares

+10 shares to 30 shares

General Dynamics (GD)

1.12%

2 shares

too small to consider

Intel (INTC)

3.14%

Exxon Mobil (XOM)

0.90%

31 shares

+30 shares to 130 shares

Chevron (CVX)

0.36%

55 shares

+56 shares to 80 shares

Pfizer (PFE)

1.03%

29 shares

+30 shares to 230 shares

3M (MMM)

1.27%

There are five DG stocks in the CCC spreadsheet with a quality score of 24 that I don't own:

  • Mastercard (MA)
  • Stryker (SYK)
  • Eli Lilly (LLY)
  • Colgate-Palmolive (CL)
  • Walmart (WMT)

MA yields only 0.47% at $280.92 per share, but the stock has a 5-year DGR of 37%! Because of MA's puny yield, many DG investors wouldn't even have the stock on their radar. But the stock is an exceptional growth stock with an impressive 10-year performance:

Unfortunately, MA is trading at a significant premium to fair value, so now is not the best time to open a position, in my view.

Much like MA, SYKis a low-yielding DG stock trading well above fair value. While SYK's growth rate is not quite as spectacular as MA's, the stock is a Dividend Aristocrat and has provided double-digit dividend growth over the last five and ten-year periods.

LLY yields 2.38% at $108.56 per share and trades about 8% above fair value. The stock has an unimpressive 5-year DGR of only 2.8%, though its most recent increase was 8%. LLY has an earnings payout ratio of 42%, providing ample room for future dividend increases.

With a track record of paying uninterrupted dividend since 1895 (and higher dividends every calendar year for 56 years running), CL is a member of two elite groups, the Dividend Kings and the Dividend Aristocrats. The stock yields 2.33% at $73.69 and has a 5-year DGR of 4.5%. This is a modest but steady growth rate.

I used to own WMT but closed my position in January 2019. The stock's five-year dividend growth rate has declined to below 3% per year and the low dividend yield just did not provide enough compensation for such a low dividend growth rate. But WMT's growth prospects seem to be improving, and I'm reconsidering my stance.

MA and SYK are not only trading well above my fair value estimates; they're also quite expensive! MA trades for about $282 per share, while SYK trades for about $214 per share. I'm not comfortable selling puts on stocks trading much above $100.

But LLY, CL, and perhaps WMT provide opportunities for put options trades. And, in fact, I sold some put options on these stocks recently:

  • LLY 17JAN20 85.0 P
  • CL 15NOV19 65.0 P
  • WMT 20DEC19 100.0 P

So I'm willing to buy LLY for $85 per share on or before 17 January 2020, CL for $65 per share on or before 15 November, and WMT for $100 per share on or before 20 December. For reference, LLY is trading above $108, CL is trading near $74 per share, and WMT is trading at about $113 per share.

DivGro Stocks with a Quality Score of 23

The next group of stocks missed on up to two quality indicators.

Only two stocks are trading below fair value, BlackRock (BLK) and Amgen (AMGN). At 2.00% and 1.26% of total portfolio value, respectively, both these positions already are larger than my average position size. Therefore, I'm not really interested in adding to these positions now.

There are three DG stocks in the CCC spreadsheet with a quality score of 23 that I don't own:

  • Costco Wholesale (COST)
  • United Technologies (UTX)
  • Emerson Electric (EMR)

COST is a low-yielding stock (with a yield of only 0.98%) but with a strong 5-year DGR of 13%. It is trading at a premium of about 17%. The stock is performing admirably over the past decade, with total annualized returns of about 20%. At $281 per share, the stock is too expensive for put-selling, so I'd have to wait for the stock to trade at more favorable levels before opening a position.

UTX and EMR both trade a little above fair value. UTX yields 2.17% at $135.63 per share, whereas EMR yields 2.94% at $66.66 per share. I decided to sell put options and choose my preferred entry points:

  • EMR 20DEC19 60.0 P
  • UTX 15NOV19 115.0 P

For UTX, I sold one $115 put option expiring in November, and for EMR, I sold two $60 put options expiring in December.

DivGro Stocks with a Quality Score of 22

This group of stocks fell short on up to three quality indicators. There are no fewer than 30 DG stocks in the CCC spreadsheet with a quality score of 22. I own only seven of these stocks:

Three stocks are trading below fair value, T. Rowe Price (TROW), Verizon Communications (VZ), and International Business Machines (IBM). While my TROW position is rather large at 2.76% of total portfolio value, I have room to add to my VZ and IBM positions. For VZ, adding 70 shares will bring my V position up to my average position size, while I could add up to 35 shares of IBM before reaching my average position size.

DivGro Stocks with a Quality Score of 21

The next group of stocks missed on up to four quality indicators. Of the 22 DG stocks in the CCC list with a quality score of 21, I own the following seven stocks:

Several stocks are trading below fair value and are good candidates for additional investment.

Company (Ticker)

Current

Weight

Needed to reach

average position size

(1.15%)

Note

Cummins (CMI)

1.05%

6 shares

+10 shares to 60 shares

Lowes (LOW)

1.24%

Comcast (CMCSA)

1.07%

20 shares

+20 shares to 220 shares

United Parcel Sevice (UPS)

0.72%

31 shares

+30 shares to 80 shares

FedEx (FDX)

0.63%

26 shares

+30 shares to 60 shares

DivGro Stocks with a Quality Score of 20

Stocks in this group fall short on up to five quality indicators. There are 29 DG stocks in the CCC list with a quality score of 20. I own six of these stocks:

Three stocks in this group are trading below fair value: Gilead Sciences (GILD), Wells Fargo (WFC), and AT&T (T). Only my WFC position is smaller than the average position size in my portfolio, and I could add up to 146 shares to make it an average size position.

DivGro Stocks with Quality Scores from 15 to 19

The next group of 18 stocks has quality scores below 20. While these are high-quality DG stocks, several of them did not score 5 points for any of the quality indicators.

With the exception of Quest Diagnostics (DGX) and Aflac (AFL), these stocks offer relatively high yields and some very impressive 5-year DGRs.

For example, Simon Property (SPG) yields 5.17% at $158.46, Philip Morris International (PM) yields 5.31% at $85.94, Altria (MO) yields 6.40% at $49.97, and AbbVie (ABBV) yields 6.33% at $67.60.

As for dividend growth, Broadcom (AVGO) and Valero Energy (VLO) have spectacular 5-year DGRs of 55% and 31%, respectively, while five other stocks have provided double-digit percentage growth rates over the last five years.

DivGro Stocks with Quality Scores below 15

I own a few stocks in the Medium-Quality and Low-Quality categories.

Notice the even higher dividend yields, illustrating the point that higher yields often go hand-in-hand with relatively higher risk. The exception is National Retail Properties (NNN), one of a few stocks with no Value Line Safety Rank or Financial Strength rating. To me, NNN belongs in the High-Quality category. I can argue a similar case for Main Street Capital (MAIN).

Concluding Remarks

Ranking the DG stocks in my portfolio by quality score is insightful. It allows me to target the highest-quality stocks for further investment. I identified stocks trading below fair value and considered relatively small positions as candidates for further investment. Doing so should improve DivGro's risk profile and increase my chances of earning market-beating returns. And adding to smaller positions will improve the overall balance of my portfolio.

While I could close weaker (lower-quality) positions and further improve DivGro's risk profile, that would come at a cost. The reason is that lower-quality stocks often have higher yields:

For now, I'm quite happy with the constitution of my DivGro portfolio. While I have one Low-Quality and a few Medium-Quality stocks, the vast majority of my stocks (53 of 74) fall in the Highest-Quality category.

I hope readers will find some value in this approach to portfolio management. Please share your thoughts and ideas in the comments. I'm curious to learn how you think about your portfolio, what your goals are, how you find candidates for capital deployment, and to what extent you focus on risk, quality, yield, growth, and valuation.

Thanks for reading and happy investing!

Disclosure: I am/we are long AAPL, ABBV, ACN, ADM, ADP, AFL, AMGN, APD, AVGO, BA, BLK, CB, CMCSA, CMI, CSCO, CVX, D, DGX, DIS, DLR, EPR, FDX, GD, GILD, HD, HON, HRL, IBM, INTC, IP, IRM, ITW, JNJ, JPM, KO, LMT, LOW, MAIN, MCD, MDT, MMM, MO, MRK, MSFT, NEE, NNN, O, PEP, PFE, PG, PM, QCOM, ROST, RTN, SBUX, SKT, SPG, SWK, T, TJX, TROW, TRV, TXN, UNH, UNP, UPS, V, VLO, VZ, WBA, WFC, WPC, XOM. 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.