After years and years of screening for, and writing about, possibly undervalued dividend growth stocks I had to take a break earlier this year. Well, after a six month hiatus I am back! My goal is the same, it is to buy $500 to $1,000 worth of one or two companies per month, every month. The company will have increased its dividend every year for 20 years or more years and hopefully will be undervalued at least to its peers.
My Screening Metrics
In an attempt to find undervalued, unloved companies I use certain metrics which are defined below. First and foremost, the company must have increased their dividends for at least 20 years. To gather this information I use the Dividend Champion list (as well as part of the Dividend Contenders list). Both lists are updated monthly by David Fish. In the past I used the Dividend Aristocrat list, but one of the criteria for the Dividend Aristocrat is that it is a member of the S&P500, however, that is not all that important to me so I use the more encompassing list.
Once I have the base list, which this month included 160 companies I start applying certain requirements on the following metrics. This list is done by hand every month and so the numbers stay static, and as such should only be used as a starting point for your research.
Market Capitalization is defined as,
Market capitalization refers the total dollar market value of a company’s outstanding shares. Commonly referred to as “market cap,” it is calculated by multiplying a company’s shares outstanding by the current market price of one share. The investment community uses this figure to determine a company’s size, as opposed to using sales or total asset figures.
Market Cap is broken down into a few categories (micro, small, mid sized, and large):
- Small Caps are usually defined as companies between $300,000,000 and $2,000,000,000
- Mid Caps are usually defined as companies between $2,000,000,000 and $10,000,000,000
- Large Caps are usually defined as companies above $10,000,000,000
I have chosen to remove any companies with a market cap of less than $500,000,000. This removed 10 companies leaving 150 to continue to screen
Pricing to Earnings Metrics
I have opted to use two separate but related price to earnings screens. I should note that even prior to opening up the spreadsheet I knew that the limitations placed on these two metrics were going to eliminate most of the available companies especially in today’s market environment. The first screen was to remove all those stocks with a P/E Ratio of over 20.
Price to Earnings is an extremely common way to value companies. It compares the companies stock price to what they actually earn. For example, if a stock is trading for $20/share and it earns $2/share it will have a P/E of 10. I think in the future, I may increase this number to 25 and then take into account the industry average after that.
The second P/E metric used was a Shiller P/E under 20. The Shiller P/E takes into account past earnings rather than just the previous quarter or 4 quarters:
Value investors Benjamin Graham and David Dodd argued for smoothing a firm’s earnings over the past five to ten years in their classic text Security Analysis. Graham and Dodd noted one-year earnings were too volatile to offer a good idea of a firm’s true earning power. In a 1988 paper economists John Y. Campbell and Robert Shiller concluded that “a long moving average of real earnings helps to forecast future real dividends” which in turn are correlated with returns on stocks. The idea is to take a long-term average of earnings (typically 5 or 10 year) and adjust for inflation to forecast future returns. The long term average smooths out short term volatility of earnings and medium-term business cycles in the general economy and they thought it was a better reflection of a firm’s long term earning power.
Shiller later popularized the 10-year version of Graham and Dodd’s P/E as a way to value the stock market. Shiller would share the Nobel Memorial Prize in Economic Sciences in 2013 for his work in the empirical analysis of asset prices.
Currently, the market as a whole is hitting all time highs in both an objective number (i.e. the S&P) as well as value (i.e. Shiller P/E), and as such, these two metrics eliminated almost all of the companies! Not a problem, but I may change the two metrics in a few months.
Operating Margin Screen
Operating Margin is defined as
a margin ratio used to measure a company’s pricing strategy and operating efficiency.
Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc. It can be calculated by dividing a company’s operating income (also known as “operating profit“) during a given period by its net sales during the same period. “Operating income” here refers to the profit that a company retains after removing operating expenses (such as cost of goods sold and wages) and depreciation. “Net sales” here refers to the total value of sales minus the value of returned goods, allowances for damaged and missing goods, and discount sales.
Operating margin is also often known as “operating profit margin,” “operating income margin,” “return on sales” or as “net profit margin.” However, “net profit margin” may be misleading in this case because it is more frequently used to refer to another ratio, net margin.
I want the companies I choose to buy to be more profitable than their industry peers.
Dividend Yield is the amount that is paid to the shareholders as it relates to the current price of the stock. So for example, if ABC company is worth $20/share and it is paying $2/yr in a dividend it has a 10% yield. There are a lot of investors that “chase yield” which is moving their capital around looking for high yield stocks. While I am not interested in that strategy, I do want to get paid for owning the company, and as such I set a floor of 2.5% yield.
Payout ratio refers to how much of a company’s earnings are being used to support the dividend. Since I am obviously interested in companies that can continue growing their dividend I do not want the payout ratio too high or else it will become unsustainable. I have set the ceiling at 60% of earnings.
September Watch List
After the above screen I was left with the following companies:
- Community Trust Banc. CTBI
- Cullen/Frost Bankers CFR
- Genuine Parts Co. GPC
- International Business Machines IBM
- Southside Bancshares SBSI
- Target Corp. TGT
- Wal-Mart Stores Inc. WMT
Of these, I already own stock in CTBI, CFR and TGT.
I am always looking for opinion or advice on the above options, or my method so please share.
Updated: Requested the actual numbers