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

Estimating Earnings and Dividend Growth (Part 1)

Our strategy seeks companies with high and sustainable return on shareholder’s equity (ROE). ROE measures how much profit for shareholders is generated for every dollar of equity capital that is invested in the business. Four levers drive the ratio: profit margins, asset utilization, management of taxes, and the amount of debt used.  Decomposing ROE into these components provides an accurate and comprehensive attribution of a corporate manager’s skill at deploying shareholder capital.
 
Earnings growth should equal its ROE MINUS what the company pays out in dividends over time. If a company generates a 20% ROE and pays out 50% as dividends, earnings should compound at 10%. Importantly, dividends should also grow at the same rate as long as management keeps the payout ratio constant. This demonstrates why a high, expanding or at least stable ROE is desirable for growth of dividends. Analyzing the four levers helps an investor determine dividend safety and sustainability of earnings.
 
US stocks are on pace to post about a 14% ROE and estimated to pay out about 47% of earnings (as estimated by Baseline). So the long term sustainable growth rate of earnings and dividends should approximate 7%.
 
Our portfolio is packed with companies that we believe can grow earnings and dividends at above average rates based on ROE evaluation.
·       16% of our portfolio has an estimated ROE above 20%
·       38% of our portfolio has an estimated ROE of over 16%
·       65% of our portfolio has an estimated ROE at least equal to or greater than the average US stock.
 
Approximately 15-20% of our portfolio has an ROE that is temporarily below average, but their businesses are rebounding. ROE’s should once again outpace the average stock in the market. These include a few large cap financials, and consumer discretionary stocks.
 
This is why we are of the opinion our portfolio can generate growth in dividends and/or cash flow at rates in the low teens.

Disclosure: no positions mentioned

Disclosure: no positions mentioned