Dividend Questions & Answers: What Are MAD Charts?
Summary
- Members have appreciated our questions/answer format, so we're making extra blog posts explaining our methodology.
- Our MAD charts are an extremely powerful tool, but many investors don't fully comprehend how they work.
- In this short article, I explain the ins and outs of one of the most useful charts for dividend investors.
Written by Sam Kovacs
Introduction
MAD Charts are an extremely powerful tool to help dividend investors pick the best stocks at the best time.
Members of the Dividend Freedom Tribe get access to MAD Charts for over 1,200 dividend paying stocks.
Let's start with an example: Johnson & Johnson (JNJ)'s MAD Chart.
Source: Dividend Freedom Tribe
So what is going on?
The chart goes back 10 years, and you get a black price line. The grey bars show dividend payments.
You then get 4 ranges, marked from undervalued in blue, to overvalued in deep red.
How are these calculated? Let's start from the outer limits.
We look at the maximum yield that JNJ has had during these past 10 years: 3.94%.
We then calculate the price at which it would have traded at different points in the past 10 years if the stock yielded 3.94%.
As the dividend increases, this calculated price increases and marks the bottom limit of the blue area. If JNJ yielded 3.94% today, it would trade at $107.
At the other end of the spectrum, the top of the dark red range shows the price if JNJ traded at its minimum dividend yield. During this past decade, JNJ never yielded less than 2.28%.
It makes sense to now go to the middle of the areas.
In the middle of the chart, between the light pink and light blue ranges, you get the inferred price if JNJ traded at its 10 year median dividend yield.
For JNJ the median yield is 2.74%.
Investors can tell in one look that if the price is in the pink or red ranges, it yields less than its historical median.
If it is in the light blue or blue ranges, it is yielding more than the historical median.
How do we set the pink and light blue ranges? We do these by looking at the 25th and 75th percentile dividend yields for the past 10 years.
For JNJ These levels are 2.58% and 2.93% respectively.
I marked these levels on the chart below for you to visualize.
Source: Dividend Freedom Tribe
As dividends increase, value increases as well. This is apparent on these charts.
How to use these charts?
The most obvious way to use these charts is to "Buy Low" "Sell High".
Consider this MAD Chart from HD.
Source: Dividend Freedom Tribe
It served well as a guideline for us to trade around our position. Buying low and selling high is an evident strategy, but one that is difficult to implement in real life without the proper tools.
Understanding changing yield ranges
One of the limitations of these charts is that they are backwards looking.
We focus dividends into the future, but we set our ranges based on historical yields.
Sometimes the growth profiles of stocks change, and higher yields are justified.
For instance look at Federal Realty (FRT). Our members bought and sold FRT despite it still being in the light blue region. Why?
The annotation of the chart below should help.
Source: Dividend Freedom Tribe
As you can see the chart above shows that while FRT grew its dividend fast in the first half of the past decade, this then slowed down, and the stock has been growing a lot slower.
Therefore it isn't a stretch to say that a stock that is growing at a lower rate, should yield more.
This is our philosophy, and it marks the limit of the MAD Chart. We use them as a point of reference for the past. If the future is similar to the past in terms of growth, then they are crazy accurate.
If the past and the future diverge, you need to take these into account when analyzing MAD Charts.
Conclusion
These serve as a tool, not as a Crystal Ball. Discretion and analysis must be applied.
That's a big part of the value we add to Dividend Freedom Tribe members. We provide commentary and discussion around the stock's we cover, so that members can intuitively understand how we use MAD Charts to find market beating opportunities.
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