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. Well, recently I started to read The Intelligent Investor by Warren Buffett’s mentor, Benjamin Graham, and I have been amazed that my rudimentary and amatuer analyst work is not completely off from this value investing founding father. I think starting January of 2015 I will adopt more of a Graham method in terms of not just selling which I already do, but for purchasing as well.
Notwithstanding, the market hit an all time high today, so I figured it was a good day to find something unloved by Mr. Market.
Activity in October 2014
I received only $47.49 in dividends in October 2014 which is lower than in October 2013. I don’t think this is a real reduction, but rather, determined by when Fidelity credits my account. It was discussed in one of my posts a few weeks ago, a quarterly graph may provide a better indication of growth, as such I have included both below:
I didn’t sell any stocks in October 2014 (I will next month to make debt obligation payments to myself) but I did purchase two lots:
- On 10/9 I purchased 9 Shares of AFL for a purchase price of $521; and
- On 10/15 I purchased 14 Shares of SON for a purchase price of $532.
I wasn’t going to go back for another purchase but when the S&P crumbled down 5%+ month over month I knew it was time to go back to my watch list and pick up something.
Undervalued Dividend Champions for November 2014
This, along with everyone of these dividend research updates, is a snap shot in time (this one was on the night of November 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 2.4% (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 55! Wow, this boring old school method knocked out nearly 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 2.4%. 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 November 2014
|Wal-Mart Stores Inc.||WMT|
|Johnson & Johnson||JNJ|
|MGE Energy Inc.||MGEE|
|First Financial Corp.||THFF|
|Sonoco Products Co.||SON|
|Community Trust Banc.||CTBI|
|Tompkins Financial Corp.||TMP|
|Arrow Financial Corp.||AROW|
I take this list and then take a look where the stock is in relation to its 52 week high and 52 week low. I figure that if the stock once hit the 52 week high I can capture some of the ride back up providing some safety.