The downturn in the market I discussed last month was pretty short lived, so it’ll be interesting to see what stocks still meet my metrics below. As a reminder, every month I buy a lot or two (currently defined as $500) of a hopefully undervalued dividend growth stock.
Screening for Undervalued Dividend Growth Companies
Dividend Growth History
The very first hurdle that a company has to pass is whether it has increased its dividend for 20 or more years. I am looking to build a sustainable income stream, and it is my hope (and all it is a hope) that if they have paid dividends for 2+ decades it is part of their DNA and so they’ll continue to do so.
I use the Dividend Champion List (25+ years of dividend growth) and part of the Dividend Contender List (10 to 24 years of dividend growth). The lists are maintained by The DRiP Resource Center.
Price to Earnings
The first metric I screen for is Price to Earnings. Price to earnings is defined as,
the ratio for valuing a company that measures its current share price relative to its per-share earnings.
P/E is probably the most popular way to value stocks. If you are reading this post you should probably already know that price in it of itself is not a measure of a company’s value. In the past I have used different ratios (under 20, under industry average, under both 20 and industry average, under 20 CAPE P/E, etc.) for calendar year 2019 I am going to focus on those stocks with a P/E under 15.
Dividend Yield and Payout Ratio
I am not dividend hunting, but I do want to get paid to have money invested with the company, so I am going to use a dividend yield of at least 2% for calendar year 2019. Much more important than the yield is the Dividend Payout Ratio which is simply the amount of earnings per share that is being used to support the dividend. While sources will have different views on the topic I like Dividends.com guidelines,
A range of 35% to 55% is considered healthy and appropriate from a dividend investor’s point of view. A company that is likely to distribute roughly half of its earnings as dividends means that the company is well established and a leader in its industry. It’s also reinvesting half of its earnings for growth, which is welcome.
Free Cash Flow Yield
New for 2019 is Free Cash Flow Yield.
Free cash flow measures the cash available to shareholders after a company has paid all of its bills in full. Buffett relies heavily on a similar metric that he dubs “owner earnings.”
One way to gauge a firm’s cash flow production is to examine its free cash flow yield. This is calculated by dividing free cash flow by market capitalization, or the inverse of the Price/FCF ratio. A firm with a free cash flow yield of 10%, for example, generates 10% of its total market value in cash each year. That cash, in turn, can be used to pay dividends or fund share buybacks — items that enhance shareholder returns.
Having seen a bunch of a different articles on the topic I liked this one best explaining where my gauge should be:
Having used the Free Cash Flow Yield a zillion times over the years, I have come up with these conservative parameters for my own investing.
For the more Aggressive, as well as the “Buy and Hold” investor, I would adjust everything down a notch, and for example, would make the hold from 2% to 5.9% and the buy from 6% to 9.9% and sell anything under 2%. As for shorting a stock that would be any result under zero, including any negative result. Here is a listing of those parameters for easy reference.
Since this is a pure buy and hold account I set my screener at 6%+ for Free Cash Flow Yield.
My June 2019 Watch List and Purchase
After the above screen I ended up with the following stocks:
| Ticker | Name | Dividend Yield | P/E Ratio | Payout Ratio | Free Cash Flow Yield |
| EV | Eaton Vance Corp. | 3.5% | 10.56 | 38.8% | 6.7% |
| TROW | T. Rowe Price Group, Inc. | 2.9% | 13.39 | 37.1% | 6.1% |
Only 2? Something had to be wrong, so I took a quick peek and saw that I lost some great companies because they didn’t spend enough on dividends (Payout ratio) which isn’t really the most important part of my screen so I added them back in:
| Ticker | Name | Dividend Yield | P/E Ratio | Payout Ratio | Free Cash Flow Yield |
| AFL | Aflac Incorporated | 2.0% | 12.99 | 25.3% | 14.2% |
| BEN | Franklin Resources, Inc. | 3.1% | 11.59 | 33.2% | 12.2% |
| EV | Eaton Vance Corp. | 3.5% | 10.56 | 38.8% | 6.7% |
| NUE | Nucor Corporation | 3.1% | 5.89 | 19.4% | 9.6% |
| TROW | T. Rowe Price Group, Inc. | 2.9% | 13.39 | 37.1% | 6.1% |
| WBA | Walgreens Boots Alliance, Inc. | 3.4% | 9.32 | 34.4% | 7.3% |
| ORI | Old Republic International Corporation | 3.6% | 8.63 | 30.1% | 10.1% |
| PH | Parker-Hannifin Corporation | 2.1% | 14.62 | 27.5% | 6.3% |
Since I currently have positions in AFL, BEN, NUE, TROW, WBA (added in May 2019) and ORI, I figured I would start looking into EV and PH to see if I had any interest in opening a new position. First thing I checked was what I was actually buying, since they did since they are not household names.
Eaton Vance is
one of the oldest investment management firms in the United States, with a history dating back to 1924. Eaton Vance and its affiliates offer individuals and institutions investment products and wealth management services and creation, marketing, and management of investment funds.
While I have at least heard of Eaton Vance being in the finance world, I have never even heard the name Parker Hannifin before, and upon looking up their main business it is not shocking,
Parker Hannifin Corporation, originally Parker Appliance Company, usually referred to as just Parker, is an American corporation specializing in motion and control technologies…The company was founded in 1917 and has been publicly traded on the NYSE since December 9, 1964. The firm is one of the largest companies in the world in motion control technologies, including aerospace, climate control, electromechanical, filtration, fluid and gas handling, hydraulics, pneumatics, process control, and sealing and shielding. Parker employs about 58,000 people globally.
I love the description! A boring company that makes sophisticated items. Next I checked PH’s outstanding shares over the past 5 years:
Look at that declining trend! I am in. I opened a new position with 5 shares of PH at $164.90 a share.
Great list. I hadn’t heard about Parker-Hannifin either; will have to dig in a bit.