For the past few years I have been using a very specific screening process with only a few changes. Once or twice a month I refer to my “watch list” and determine stocks I should purchase in $500 or $1,000 lots. My goal is to find undervalued companies that have been increasing dividends for the past 25+ years. To determine what is undervalued I refer to a company’s Price to Earnings, Operating Margin, Price to Book and then further deselect companies based on yield and dividend ratio.
For the first time in a long time I did not do a monthly last month (December 2014). The reason was simple, as I sat down to do the research (which I still do painstakingly by hand) one of my long term holds, CVX, took a nose dive so as I discuss in detail below I decided to just purchase more shares.
Activity in the Dividend Portfolio for November and December 2014
In November I purchased 9 Shares of Aflac and in December I purchased 5 Shares of CVX. For CVX I simply just took a look at Morningstar to make sure nothing happened within the company’s metrics and instead the steep decline pictured below was due to oil prices decreasing significantly:
Uncharacteristically, in December 2014 I sold 2 pretty big positions (in terms of value of equities to total portfolio size) and 1 smaller position.
- On 12/18/14 – I sold my entire stake of Walgreens. 31 Shares at $74/share which represents a 100%+ gain inside of 2 years. It is currently trading at a 35+ P/E.
- On 12/23/14 – I sold my tiny 6 Share stake in PG at $93.31/share which represents a 48% Gain in 2.5 years. When I sold it had nearly 30 P/E
- On 12/23/14 – I sold my entire stake of Target -41 Shares at $74.41 which represents a 20% or so gain in a year’s time. Again it is over a 30 P/E
I am not completely sold on the idea that I should be selling anything out of this account, but the valuations of the three companies combined with my unrealized gains made me want to sell. For the first time I also took out $2,000 from the account to pay down some debt.
My dividend income is trending the correct way for month over month, quarter over quarter and year over year:
Undervalued Dividend Champions for January 2015
This, along with everyone of these dividend research updates, is a snap shot in time (this one was on the night of January 5, 2014). So please don’t use my data as anything but a starting point for your own research. I use the metrics below to get to a “watch list” which I use to try and purchase equities closer to their 52 week low.
My Dividend Investment Portfolio Screening Criteria
The first five steps’ data is taken, manually, from Morningstar while Dividend Payout Ratio is taken from Dividend.com:
- The company has paid increasing dividends for at least 20 years – 154 entries this month!
- The stock has to have a Price to Earning that is lower than their industry average. The Price to Earnings Ratio has to below 20 regardless of industry average.
- The Operating Margin has to be in line with the particular stock’s industry average. I want companies that are profitable as compared to their peers.
- Price to Book – Should be below 4, but if it isn’t it must be in line with industry average (or lower).
- This monthly update the Dividend Yield should be above 2.5% (changes whenever I update the list depending how many stocks I have left after the first 4 steps).
- Dividend Payout Ratio – It took me a long time to add this to my screen but basically I weed out any companies paying over 60% to shareholders. Couple reasons. The main one would be sustainability, but also, I do want growth in a company and if all dollars are going out it is likely to hurt the company in the long run.
Since this is a snapshot I am not that strict since I am well aware that if the underlying company opens a tenth of a percent the other way it could pass a metric.
Definitions of Metrics Used for my Dividend Investment Portfolio
Since not everyone knows what I am talking about above I have provided definitions (all quotes taken from Investopedia):
- Dividend Champions are those dividend paying American companies that have increased their dividend for the past 25 years. Unlike the Dividend Aristocrat list they do not have to be part of the S&P 500. I have included a part of the dividend contenders list (20+ years but less than 25).
- P/E is Price is “a valuation ratio of a company’s current share price compared to its per-share Earnings.”
- 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. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt.”
- Price to book is a ratio used to compare a stock’s market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share.
- Dividend Yield a “Financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated by dividing Annual Dividends per Share by Price Per Share”
- Payout Ratio – “The proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage…The payout ratio is a key financial metric used to determine the sustainability of a company’s dividend payments.
Applying My Stock Screen Criteria to the Dividend Champion List
First Stock Screen: PE Ratio
The first Stocks I their eliminated were those whose Price to Earnings Ratios were out of line with their industry average. I also eliminate companies with PEs above 20 regardless of their industry average. This brought me down from 154 equities to 51! Wow, this boring old school method knocked out over 100 contenders.
Second Stock Screen: Operating Margin
Next I eliminated those stocks whose operating margin was not better than its peers in the industry. I want the companies I invest in to be more profitable than their peers. This way unless there is a huge problem with the industry they’d be less likely to stop doing something (i.e. paying increasing dividends) that they have been doing for the past 20+ years
Third Stock Screen: Reasonable Price to Book or in line with their Industry
I was looking for those stocks whose price to book value is low as to further evidence that it is undervalued. In an effort to limit the unintended consequence of choosing stocks with a lot of tangible or financial assets on the books I have started comparing the P/B to the industry average.
Fourth Stock Screen: Yield
While I am not ‘chasing yields’ I am attempting to create a dividend portfolio, so the next elimination step was to remove any stocks with a dividend yield of less than 2.5%. This is a moving target depending on how many stocks I have left to choose from. Sometimes I go for 2% sometimes 4%
Since yield in of itself is derived from price this is another indication of a hot market (not that we needed one).
Fifth Stock Screen: Payout Ratio
Next, I eliminated those equities whose payout ratio was 60%+. I am not sure if this was a good level but from the articles that I have read indicate that is the top end for most stocks.
Undervalued Dividend Watch List for January 2015
|Johnson & Johnson||JNJ|
|First Financial Corp.||THFF|
|Sonoco Products Co.||SON|
|Tompkins Financial Corp.||TMP|
|Community Trust Banc.||CTBI|
|Arrow Financial Corp.||AROW|
A significantly shorter list than previous months (I usually end up with 20 to 30). When prices move out of whack with historical safe numbers I use this list will become shorter and shorter. I now take the above 11 and research how far they are from their 52 week low and 52 week high looking for stocks that are far from their 52 week high building in a (sometimes) easy few points to get back up to a number they have already hit.