I'm in the midst of assembling a first class dividend growth portfolio. Rather than insert an unwieldy section into each article explaining the process and listing results, I'll be referring readers here. Here's a list of dividend paying companies that passed the initial screening. Following each evaluation, I'll insert the score and a link to the evaluation in the table below:
Note: If you don't understand what I intend to accomplish with Moaty Chowder, there's a nice explanation under the table.
Let's begin at the bottom of the pyramid. The initial screen brought to the surface all companies with at least a five-year history of annual dividend raises. This was fairly easy as it is simply David Fish's invaluable Champions, Contenders, and Challengers list.
While I doubt that I need to explain the importance of selecting companies with a history of increasing distributions, the next step of the screening process was less straightforward. With the average company on the CCC list offering less than 3%, I could hardly limit my search to companies with an acceptable current yield. I had to expand the search to companies likely to increase yield to a satisfactory rate in the near-term. This is why I selected companies that passed, or nearly passed, the Chowder Rule. This test adds five-year dividend growth rates to current yields. I selected companies with a score above ten.
The following step of the initial screening process is even less straightforward. I'm looking for companies likely to continue increasing earnings, and in turn distributions, over the long term. For this step I turn to Warren Buffett and his famous "economic moat" concept. If you're unfamiliar, stop now and don't invest another dime until you understand it fully.
The overarching theme for this portfolio is fear of competition. When competing companies race each other to the bottom, shareholders lose. In an effort to stay focused on companies likely to remain highly profitable for the long term I only selected those with a wide moat rating from Morningstar.
With an initial list of about 30 companies, it's time to dig a little deeper in search of the best opportunities. To do so I'll look at five criteria, awarding a maximum of five points for each. Those criteria are near-term outlook, dividend history, dividend sustainability, economic moat, and profitability. Companies scoring highest in total will be first to undergo more rigorous analysis and valuation. Candidates will only be added to an eventual portfolio following a favorable valuation.
Let's look at the criteria for selecting candidates, beginning with near-term outlook. Even a great company will have trouble returning value to shareholders if it's in a poorly positioned industry. This is why each company will receive a fairly subjective score for its near-term outlook. Stagnant core growth, currency headwinds, and unfavorable industry trends are all factors that would lower this score.
Dividend history is possibly the most objective ranking. Champions, contenders, and challengers will receive three, two, or one point respectively. The following two points will be given to companies with outstanding recent dividend growth. Past performance never guarantees future results, but it's still one of the best indicators at our disposal.
Companies will also be evaluated for dividend sustainability. Excessive debt burdens, and high payout ratios are can cause a company to lose points in this segment. While it might seem like a great idea to chase a 6% yield that's grown at 15% annually for five years. If that company is distributing all of its profits, those payments won't continue much longer. A full score will go to companies likely to maintain satisfactory dividend growth even in the face of an extended rough patch.
All companies that passed the initial screen presumably have a wide moat. In the economic moat segment I will make a qualitative assessment of the company's competitive advantage. Remember we're looking for companies able to produce outsized profits for at least another decade. Companies with economic moats likely to provide pricing power for its goods and services for at least another decade will receive full points for this segment and vice versa.
Finally, the profitability segment will attempt to quantify the effects of each company's moat. We'll look at margins, free cash flow as a percentage of sales, returns on equity, and invested capital. I suppose you could consider this a measurement of a moat's depth.
Extremely profitable companies like Pepsi, are able to maintain a decent level of core growth despite retaining a small portion of profits for reinvestment. This frees up cash for distribution to shareholders in the form of dividends and share repurchases. Companies receiving five points in this category will display an ability to maintain satisfactory EPS growth, and in turn dividend growth, with minimal reinvestment of profits.
As you can see, I've written a number of articles for companies in the Moaty Chowder list prior to implementing a rating system. Since these posts largely focus on factors within the Moaty Chowder rating system I've included their links in the above table. Once rated, I'll include the most recent links.
In the meantime I would love to read your thoughts, and answer your questions. Don't be shy!
Disclosure: The author is long KO, PG, JNJ.