For the longest time I would create an undervalued dividend growth watch list and then wait until the following month to write a post about which stock I bought and why.  Looking back, it was kind of silly because in reality I would simply buy the stock the next day anyway so why wait to share especially since time has passed and remembering my reasoning a month later was damn near impossible.

## My Screening Method for Under Valued Dividend Growth Stocks

I used to use metrics based on the price of the stock (P/E, P/B, Yield, etc.), however, earlier this year, I finished Tobias Carlisle’s book, The Acquirer’s Multiple, and decided to give the valuation method a chance.  The method was very different than what I had been previously doing for the past couple of years.  It focuses a lot less on using price as the main metric and more on the balance sheet and earnings.

Despite really enjoying the book, I decided to use a slightly different formula, the Magic Formula by famed hedge fund manager Joel Greenblatt.  The reason I made that decision was not because I believed one guru over the other it was simply because of what I could obtain in a free screen. I am in the middle of Mr. Greenblatt’s book, The Little Book that Still Beats the Market, and hope to write a lot more about it next month.

## What is the Magic Formula

The Magic Formula,

is a quant screen…that identifies great companies selling at a discount. The process is simple. To identify great companies Greenblatt screens for companies with a high return on invested capital (ROIC). And to identify companies that are “cheap” Greenblatt uses the company’s earnings yield.

The formula is basically Enterprise Value/EBIT.  Enterprise Value is,

a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents

is an indicator of a company’s profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is calculated as:

EBIT = Revenue – Operating Expenses (OPEX)

or

EBIT  = Net Income + Interest + Taxes

EBIT is also referred to as Operating Earnings, Operating Profit, and Profit Before Interest and Taxes (PBIT).

## How Did I Screen for the Magic Formula?

After way longer than I’d like to admit I found an amazing, free site to easily screen for EV/EBITDA (rather than EBIT).  The site is called FinBox and I would highly recommend it for anyone that is trying to screen for almost anything.  The EV/EBIT is a premium feature on the site, and I may opt to sign up for the service in the future, but right now, I am just learning about this method of valuing companies.

## My August 20108 Dividend Growth Watch List and Purchase

First thing I did was create a screen for those companies with a magic formula of less than 10, a dividend yield of at least 1.5% and a P/E under 25.  This gave me a list of 340 companies.  At the same time I wanted companies that have increased their dividends at least 20 years, so I turned to the dividend champion and part of the dividend contender list which provided 165 companies.  Cross referencing the two left me with the following 16 companies:

 Ticker Name Sector T AT&T Inc. Telecommunication Services CVX Chevron Corporation Energy CBU Community Bank System, Inc. Financials EV Eaton Vance Corporation Financials XOM Exxon Mobil Corporation Energy MGRC McGrath RentCorp Industrials NC NACCO Industries, Inc. Energy NFG National Fuel Gas Company Utilities NUE Nucor Corporation Materials TGT Target Corporation Consumer Discretionary TDS Telephone and Data Systems, Inc. Telecommunication Services UGI UGI Corporation Utilities WBA Walgreens Boots Alliance, Inc. Consumer Staples BPL Buckeye Partners L.P. Energy ENB Enbridge Inc Energy CAH Cardinal Health, Inc. Healthcare

### Narrowing the Watch List

To further narrow the list, I respected the formula which states to remove financials and utilities.  I also removed any stock that is in health care and energy.   This left me with the following companies:

Ticker & Name

• T AT&T Inc.
• MGRC McGrath RentCorp
• NUE Nucor Corporation
• TGT Target Corporation
• TDS Telephone and Data Systems, Inc.
• WBA Walgreens Boots Alliance, Inc.

I then looked up each companies outstanding shares.  I wanted to see either visually decreasing number outstanding shares or at least a stable amount shares.