Undervalued Dividend Growth Screen and Purchase – September 2019

by Evan

Every month I screen for undervalued dividend growth stocks and buy a lot (as defined by me as $500) or two.  My goal is that one day I can turn off the dividend reinvestment option and start taking a stream of income.  This month I’ll be purchase two lots because I missed last month due to the house purchase and the flux my financial life was in at the time.

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.

Over the past few months I found that I was eliminating some otherwise investable stocks just because they were under 35% and that didn’t/doesn’t make a whole lot of sense to me.  So anything over 55% is eliminated.

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 September 2019 Watch List and Purchase

After screening the original list against the metrics above I was left with the following companies to take a deeper dive on:

Ticker Name Dividend Yield P/E Ratio Payout Ratio Free Cash Flow Yield
WBA Walgreens Boots Alliance, Inc. 3.3% 10.48 35.1% 6.5%
AFL Aflac Incorporated 2.1% 12.23 25.2% 13.0%
NUE Nucor Corporation 3.0% 6.98 22.1% 7.3%
CAH Cardinal Health, Inc. 4.0% 10.59 42.3% 12.0%
ORI Old Republic International Corporation 3.5% 9.12 31.6% 10.2%

I really like all these companies and I have a position in all of them except CAH.  I don’t really like the idea of investing in health care companies so I shy away from them.  So I think for the first time I am going to buy 4 half lots in the others.  I am way over paying in fees but at $5 a trade does it really matter?

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1 comment

JC September 13, 2019 - 1:41 pm

I like WBA around these prices. CAH I know was pretty popular for a while but I always shied away from them. IIRC it’s pretty much just a spread/distribution type business. With the other businesses in the industry competing on cost it really drives margins down.

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