I made a decision late last year, that every 6 to 9 months I am going to look at different factors to determine whether a stock should be on my watch list for that month. I didn’t write a post about it, because there wouldn’t be much to discuss without the actual plan. I the reason I came up with this decision is pretty simply that I don’t know what I don’t know. If I had a screening plan that I knew was the answer I would have a a fund versus a small little account.
I have been sharing my screens for years and years and years. Over those years I have bought, sold and much to my horror and anger withdrawn. No More. I plan on zero withdrawals for the foreseeable future – so I will continue to sell puts and buy dividend growth stocks.
In the end I hope this exercise provides me with different companies I haven’t seen in a while on my watch list that I’ll be pumped to own in 5 to 10 years. Worse comes to worse, I end up looking at the same handful of stocks and that’s okay because that means after a few different screens they are the ones to watch and buy!
I should mention that the one thing that isn’t changing – my starting point. My screen has always started with companies who care about increasing their dividends. For the past few years that number has been companies that have increased their dividend for at least twenty years.
What I plan on Using for Version 3 of my Dividend Growth Screen
Going forward I am going to use the following metrics when screening for undervalued dividend champions and contenders.
Price to Earnings Ratio
Price to earnings ratio has been involved in my screen since the beginning. It is the most basic of valuation methods. Investopedia defines price to earnings as,
The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings
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In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. This is why the P/E is sometimes referred to as the price multiple because it shows how much investors are willing to pay per dollar of earnings
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To calculate the P/E ratio, the earnings per share (EPS) must be known. EPS is most often derived from the last four quarters. This form of the price-earnings ratio is called trailing P/E, which may be calculated by subtracting a company’s share value at the beginning of the 12-month period from its value at the period’s end, adjusting for stock splits if there have been any.
At first I used under 20 P/E and under industry average. Then in my last iteration I used the Shiller P/E as well. This time around, I am going to use just the fact that it is under the industry average.
Payout Ratio
This metric was used since near the beginning of my screens, and I’ll continue to do so since the cutting of any dividend would be disastrous. It was suggested by a reader many years ago, and is one of the reasons I am happy to share these types of posts because I am actually looking for feedback.
the percentage of a company’s earnings that are paid out as dividends.
There is no magic number. A low payout ratio may indicate that there is plenty of room for the dividend to grow and that it has plenty of cash to use in other projects…but it also may mean that the company doesn’t care about sharing those profits with shareholders. Too high of a number and while I am collecting more of the company’s profits in cash it may be unsustainable to grow that amount (and further it may limit the company’s ability to invest in growing the company).
My limit for the time going forward I am going to eliminate any company whose pay out ratio is over 60%.
Return on Equity
I have never used this metric but I have heard a lot about it recently. Return on Equity is defined as,
the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.
Price to Book
Last but not least, I am going to use Price to Book which is defined as,
Price-to-book value (P/B) is the ratio of market price of a company’s shares (share price) over its book value of equity
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For value investors, P/B remains a tried and tested method for finding low-priced stocks that the market has neglected. If a company is trading for less than its book value (or has a P/B less than one), it normally tells investors one of two things: either the market believes the asset value is overstated, or the company is earning a very poor (even negative) return on its assets.
In the past, I used a P/B of 4 as my metric. I found that my watch list ended up being heavy in certain industries because it is natural for those industries to have a lower P/B. As such, going forward I am going to make sure the companies on my watch list have a lower P/B than the industry average.
This is always evolving, so if you have any ideas to share please do so!
Looks like a solid plan Evan. For screening purposes it might be better to use ROIC instead of ROE since ROE can get juiced up by debt levels. ROIC let’s you know what the business is earning on the total amount of capital, debt and equity, invested in the business.
That makes a ton of sense, but it isn’t a default on Gurufocus which is what I use to try and narrow down the 150+ stocks. It takes freaking forever already! To have to open up another tab would deter me. Doesn’t book value take into account debt? Would the company be screened out that way?
Nice metrics!. I tend to use FCF to compute dividend payout ratio
A lot of the podcasts I follow use FCF as well. I’d love if you can share a bit more how you use it? Have you written a post or town on the subject?