How To Pick Dividend Growth Stocks – A Fully Revealed Model
Key Ideas
- An explanation of what dividend stocks can help you accomplish.
- 5 steps to better dividend stock investing.
- How to use the quadrant strategy.
Editor Note: This is a guest post from Mike who manages dividend growth stocks portfolios. (affiliate link) He reveals his entire dividend stock investment model for free in this extremely valuable, educational article. It is a complete system for dividend growth stock selection. Take it away Mike…
I started investing back in 2003 when the bull market made everything easy.
Between 2003 and 2006, I made enough money to buy my first house with a 25% down payment. Those were the good years.
While I spent numerous hours in front of my computer analyzing trends and company fundamentals to become a successful investor, many other investors just picked stocks based on the news and made almost the same returns. The economy was booming, and we were able to find stocks doubling within the year.
Then 2008 Happened
I was somewhat lucky when the 2008 bear market occurred because most of my investments were cashed out in 2007 to buy my second house. Even though I was still hit by a -27% drop in my portfolio, the total dollar loss wasn’t too bad because my account was much smaller.
Anyway, I was too busy working my way up the corporate ladder and completing my MBA to worry about it. I didn’t have much time to invest my money.
From 2003 to 2008, I had a very aggressive investing model making a few trades per month on average. I was fast on pulling the buy and sell trigger in order to generate more profit.
But after 2008, the game changed and I didn’t have enough time to continue with my original investing plan. Plus, losing 27% of my portfolio in one quarter had left a sour taste in my mouth. This is what drove me, in 2010, to develop the dividend investing strategy I share with you here.
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How I Developed My Own Dividend Growth Model
Over the past 4 years, I’ve continuously tweaked my dividend investing strategy to achieve two goals:
- Build a powerful portfolio– able to generate both capital and dividend growth
- Keep it simple but efficient– I wanted to build a simple investing system that works consistently
I’ll tell you upfront, I don’t hold the key to becoming a millionaire through dividend investing. I still make mistakes, but they are rarer and smaller than most investors. This is how I was able to beat the market in 2012 & 2013 with my dividend stock picks.
In 2012, I wrote a very popular book about dividend growth investing, Dividend Growth: Freedom Through Passive Income, and received hundreds of emails. People wanted to take charge of their investment portfolio because they were upset about their advisors' inability to answer their questions and/or the high fees they were paying. And while I received many different questions, two main points kept coming up:
- The lack of time to build and manage a solid dividend stocks portfolio
- A systematic method for buying and selling dividend stocks.
This is when I realized that I had battled with the same issues and found a way to solve these two essential investing problems. Over the past four years, I’ve worked on an investing strategy that doesn’t take me forever to apply and tells me when to buy and when to sell stocks.
Below I will share that same dividend growth model with you. It's the same model I’ve used that has performed so well over the past few years.
A Dividend Growth Model That Works
As I’ve previously mentioned, my investing strategy is built on a simple but efficient model. It is relatively straightforward and easy to implement, but it requires discipline. That is the success of my strategy.
Let me break it down step-by-step for you:
Step 1 – Start with Stock Filter Research
I start the investment selection process with a stock filter. I use a paid subscription to Ycharts (no affiliate link here) as it provides an enormous quantity of information. But you can achieve almost the same results with a free stock filter called FinViz.
FIN VIZ stock filter doesn’t provide the 5 year dividend growth metric. This is one of the reasons I use Ychart (and the fact that I can create multiple charts to compare several metrics at the same time!) But if you prefer the free way, you can still select other metrics to pick stocks that will show great dividend growth. Below are the metrics I use:
Valuation:
- Dividend yield: over 3%
- P/E Ratio: under 20
- Forward P/E Ratio: under 20
Company Fundamentals:
- EPS Growth next 5 years: positive
- Return on Equity: over 10%
- Sales Growth past 5 years: positive
- EPS Growth past 5 years: positive
- Payout ratio: under 70%
This is enough to give you a good list to work with. It’s not perfect, but you will discard several bad stocks in a blink of an eye with these filters. (Editor Note: This approach is called stock factor modelling. It will be discussed in greater depth in future posts and podcasts.)
Step 2 – Sort For Sales and Earnings Per Share
Everyone first wants to look at dividend payouts, but I think it’s more important to look at revenues and earnings. If sales are not up, chances are profits won’t keep an uptrend. It's really common sense: if you can’t generate sufficient cash then how can you pay dividends?
The relationship between sales evolution and earning per shares will tell you 3 things:
- How is the company’s main market doing (are sales growing?)
- How are the company’s profits growing (are they making more profit or not?)
- How are the company’s margins doing (if the sales and EPS graph don’t head in the same direction that can be a red flag)
Below is an example of a combination of EPS and Revenues graph with two different companies in the same industry.
The first is Procter & Gamble (PG)
As you can see right away, there is a call to action to dig deeper inside the financial statements; the sales are going up but the EPS is trailing behind. There must be something hurting the margins or special expenses that won’t happen in the future. You need to get these facts straight before you can consider buying this stock.
However, if you look at Colgate-Palmolive (CL) you will find a more consistent trend (but not perfect):
Step 3 – Analyze Dividend Growth History
Now that you've created a list of companies able to pay dividends over the long haul, it’s time to perform some deeper analysis.
The process of choosing final “buy” candidates from your screener list can't be formulated in a rules-based structure here because it will be different for every investor based on risk preferences, portfolio objectives, and personal preferences. Instead, what I will do is provide several ideas for you to consider in developing a selection process that specifically matches your objectives.
The first thing to do when choosing final “buy” candidates is to download the company’s financial statements. Often, you will find an “Investor Fact Sheet” or “Recap” giving you some key ratios such as Earnings per Share, Sales, Profit, and Dividend Payouts over past years.
If you can’t access this information from investor fact sheets then you’ll have to dig inside the company financial statements. Another alternative is the annual report because it will provide more than one year of information with all the necessary numbers already calculated for you.
I like to use the past 5 years when analyzing dividend growth history. Also, I suggest you make a quick graph of the past 5 years' dividend payouts instead of simply calculating the dividend annualized growth rate. This will give you a clear idea of which stocks have a strong dividend payout strategy compared to the others. The graph can be as simple as the following:
Which looks a lot better than the following:
The first graph is a good indication of a solid company that is looking to consistently increase its dividend year after year. You want to invest in companies with a favorable dividend policy.
Step 4 – Examine For Sustainability
If this seems like a lot of work, it is important to note that we are only halfway through the process. That is why I offer an affordable alternative that does all of this for you for just $15 per month. (Affiliate link.) After all, if picking double digit dividend growth stocks was easy, we would all be rich!
As a quick recap, what we've done so far is examined past data with stock screeners and financial statements as an efficient way to clear out the most “unreliable” stocks. Your next step in this process is to examine current information about the company to see if it will be able to increase and sustain its dividend.
- How is the Management?
Something that is ignored too often is the current management team. Have members been there for a while and are they responsible for the previous performance? If so, are they still on board to continue their good work, or are they just trying to get their golden parachute?
The management compensation system explained in the financial statements along with the longevity of the board will help you make up your mind about their competence. If you are lucky, they might even disclose their dividend payout philosophy for the upcoming years. If they put a lot of emphasis on the dividend in their financial statement then that’s a great sign it is a focus that will continue into the future.
- How Does the Company’s Recent Quarterly Performance Look?
Besides pure metrics, which we analyzed in Step #2, recent quarterly results will tell you if the company has been beating analysts’ expectations. In addition to analysts’ opinions, you can check to see if the company is confirming their previous sales guidance. A good site to get this information quickly is Reuters because they usually report when companies comment about their outlook for the upcoming year. This is a good way to interpret the current and forward results.
Your objective in this step is to find companies confirming or increasing their earnings and sales guidance for the upcoming quarters.
- What Projects Are They Currently Pursuing?
While you are looking for financial ratios within the financial statements, also look at their current and future projects as well. A company dominating its sector must always look towards the future. For example, Intel (INTC) has been dominant in the PC world. However, they are experiencing problems entering the tablet and smartphone sectors. Since PC sales are slowing down and INTC is still not able to expand into other markets, future growth will be harder to achieve and margins will likely be reduced.
I personally looked into INTC and saw that they are multiplying their efforts in order to expand their niche into other markets. Following these current projects will tell me if INTC can successfully transition their previous business model (being the leader in processor chips for PCs) to a new business model (which not only includes tablets and smartphones but also servers and hosting services). Again, the goal is sustainability of the dividend and this is yet another quality indicator.
Step 5 – Look To The Future
All of this analysis of past data and company fundamentals serves one purpose – to figure out if the company can continue its dividend payout strategy. It is not a Crystal Ball, but it’s your best indication of future results.
A stable evolution of past sales, earnings and dividend payout ratio are all positive indications for the future dividend. If the company has a proven ability to generate growth and manage earnings then chances are good that their payout ratio will remain stable over time. It’s important to form your own opinion about the company instead of blindly believing what you read.
However, even if everything looks good, it is still important to remember that market and technology innovations can cause bad things to happen to good companies. That's why you want to determine:
- If the company is solid enough to weather a recession?
- What kind of impact would a sales slowdown and pressure on margins have on the dividend payout?
- Is the company distributing all their profits (i.e. high dividend payout ratio) or is there room for bad luck?
Once you reach this point in the analysis then these questions are easily answered. That’s why it is so important to have your own opinion with the economic facts to back it up.
From Stocks Picks To Dividend Portfolio
Now that you’ve had fun screening stocks and sorting for fundamentals, it’s time to get serious: how do you build your portfolio?
Do you simply invest in a random selection of 20-30 stocks from your list and rake in the dividends? You can certainly do that (I know investors that have a few Dividend Aristocrats and just wait for their quarterly payout), but my experience says you can do a lot better with proper selection.
The purpose of the rest of this article is to provide you with the tools you need to build your portfolio from your final list. These techniques don’t contain the absolute truth, but they will prevent you from mistakenly chasing too much yield or too much growth without properly considering investment fundamentals.
My favorite technique is to build quadrants to compare stocks, use diversification to your advantage – and as a bonus – I’ll also show you how to cheat on your investing strategy.
How To Use The 4 Quadrant Strategy
The first thing you should do when building your portfolio is to test the stocks that passed the screening criteria against 4 different types of quadrant analysis.
Quadrant analysis techniques are used to quickly compare how stocks rank relative to each other. It also reveals specific shortcomings not easily found through other analysis techniques. What is cool about quadrants is that they are easy to use, easy to understand, and don’t require much time.
The idea of building a quadrant system is quite simple: first, you select two characteristics you want to compare (consider dividend yield and dividend payout ratio). Next, you compile the data for both characteristics for all stocks on your shopping list that passed the earlier screens. Once you have all the data, you simply position each stock according to its yield (on the X Axis) and their payout ratio (on the Y Axis). Here’s a quick example:
In this example, it is quite obvious that you would like to see as many of your stock picks in the #4 quadrant (high dividend yield with low payout ratio) as possible. The least attractive quadrant is #1 (low dividend yield with high dividend payout ratio). Within minutes, you can determine which stocks are a good addition to your portfolio and which are not.
Different quadrants can be used to cross-compare related data to see contradictions and inconsistencies thus allowing you to further narrow your shopping list. Companies use quadrants to position their products (high-end vs low-end, mass consumer vs. niche, etc.) We will use them to position your stock.
For example, if you hope to live off dividends one day, you need stocks that:
- Provide a healthy dividend from day one.
- Grow their dividend over time.
- Grow their income over time (so they can keep up with their dividend and provide you with capital growth at the same time).
In order to find those stocks, you would want to use the following four quadrant models…
Dividend Yield Vs. Dividend Payout Ratio
The next quadrant we will look at compares the stock’s dividend yield to its ability to continue paying the dividend (the dividend payout ratio). In other words, most dividend investors first look at dividend yield. But instead of chasing yield blindly, like a dog running after a cat that just crossed a boulevard, you should check the dividend payout ratio to make sure your dividend (or your dog) doesn’t get squished!
Using an actual example, I’ve pulled 10 stocks from the S&P 500 and the NASDAQ to show you how they compare using this first quadrant analysis. Here’s my data compilation:
| Ticker | Dividend Yield | Dividend Payout Ratio |
| T | 5.63% | 259.00% |
| CPB | 3.67% | 47.20% |
| HRS | 2.93% | 21.60% |
| AFL | 2.87% | 28.11% |
| MSFT | 2.48% | 23.33% |
| BMY | 4.03% | 60.96% |
| GIS | 3.09% | 40.56% |
| CVX | 3.02% | 22.83% |
| BLK | 2.93% | 43.39% |
| GRMN | 3.83% | 59.62% |
As you can see, you have both high and low dividend yields and payout ratios. That doesn’t mean, however, that all of the low yields have a low payout ratio and vice-versa. This is what the quadrant will show you at a glance:
The less attractive quadrants, in my opinion, are above the 100% line. It really doesn’t matter how high the dividend yield is because they’ll eventually have to cut the dividend or sell assets to balance the books when paying out more than 100%.
Since we only have one stock in that category (AT&T), I would go back into their financial statements and calculate their payout ratio myself. Unfortunately, data on payout ratios can be less than accurate when you use free sources (the 259% payout ratio was taken from Yahoo Finance back in April 2012). But T is showing such an attractive yield for a large utility that I think it’s worth a little bit more investigation to understand why the payout ratio is so unsustainably high.
In an ideal world, we would only pick stocks in the #4 quadrant because those stocks should provide high & sustainable dividend yield. Fortunately, many of the stocks on our list are part of this quadrant (GRMN, BMY, CPB, GIS & CVX) and we have three stocks very close (BLK, HRS & AFL). Those stocks show a great combination of good dividend yield with a sustainable payout ratio.
Dividend Yield Vs Dividend Growth
Once you've narrowed your shopping list to companies showing sustainable dividend levels, the next step is to sort these same companies for dividend yield compared to dividend growth.
The goal is to find high dividend yield-payers with low payout ratios that also show 5 year dividend growth. Conversely, you want to avoid companies with a temporarily high dividend because its price has been devalued due to recent news or a market downtrend.
When comparing dividend yield and dividend growth over 5 years, you want to pick the highest yield with the highest dividend growth. Continuing the same example, here is my data for the following quadrant:
| Ticker | Dividend Yield | 5 Yr Dividend Growth |
| T | 5.63% | 5.05% |
| CPB | 3.67% | 8.83% |
| HRS | 2.93% | 22.69% |
| AFL | 2.87% | 15.80% |
| MSFT | 2.48% | 13.63% |
| BMY | 4.03% | -2.24% |
| GIS | 3.09% | 11.13% |
| CVX | 3.02% | 8.86% |
| BLK | 2.93% | 23.85% |
| GRMN | 3.83% | 31.95% |
You can already guess that BMY will get eliminated in this analysis. Here’s the quadrant:
This time, the most interesting quadrant is #2 because it provides stocks with high dividend yield and high dividend growth. GRMN is a great example. However, we also have BLK, HRS & AFL showing a strong dividend growth (over 10%) with a divided yield closer to 3%. CVX and CPB are close runner-ups because of decent dividend growth too (8.86% and 8.83%). You can see that, for a second time, MSFT is being penalized in this analysis due to a low dividend yield compare to other stocks.
Use this quadrant analysis to build your portfolio. More aggressive investors might ignore MSFT, while retirees might consider it a reasonable choice because of its leadership position within its industry accompanied by strong dividend stats.
5 Years Dividend Growth Vs. 5 Years Revenue Growth
The first two quadrants showed you stocks offering a combination of attractive dividend yield and dividend growth. The next two quadrants will take a different look at the same stocks to determine if they can sustain their dividend level over time.
Why compare the five years dividend growth with the five years revenue growth? Because the first depends on the latter. Since dividends are paid with after tax income, you want to make sure the company has enough funds to maintain its dividend payouts. More importantly, it will tell you more about the dividend distribution strategy of the company.
Low dividend growth combined with high revenue growth (quadrant #1) demonstrates that the company is in a growth stage. The company believes it's best to use cash flow to push the company to another level instead of giving back to the shareholders. This might be good if capital gains are your goal, but it’s not desirable when seeking dividend growth.
Alternatively, high dividend growth with negative revenue growth (quadrant #4) demonstrates that something is wrong and requires further investigation. In these situations the company dividend payout ratio will increase over time, which is not a good sign for an investor.
The perfect scenario would be to find a company with a steady dividend growth and revenue growth at a similar level. This tells you that the company is growing and has the intention of giving money back to its shareholders at the same time. Staying with the same sample stock list, below is the data:
| Ticker | 5 Yr Dividend Growth | 5 Yr Revenue Growth |
| T | 5.05% | -18.83% |
| CPB | 8.83% | 6.83% |
| HRS | 22.69% | 21.91% |
| AFL | 15.80% | 7.20% |
| MSFT | 13.63% | 17.63% |
| BMY | -2.24% | 28.37% |
| GIS | 11.13% | 13.27% |
| CVX | 8.86% | 11.50% |
| BLK | 23.85% | 26.17% |
| GRMN | 31.95% | 2.61% |
Before looking at the quadrant, you can already see that BLK and HRS are following an interesting trend on both revenue and dividend growth. Now let’s take a look at the big picture:
Notice how things get clear on a great graph?
We have only 2 stocks in quadrant #2 showing both strong dividend and revenue growth; however, we also have 3 interesting stocks (MSFT, GIS & CVX) in quadrant #1 showing a great combination. We can also see that BMY & T are far from being in a strong position in this quadrant. GRMN obviously shows a shift in direction while they have decided to become a “strong dividend-payer” over the past several years. This is quite logical for an established company with a lot of cash flow (after powerful dividend growth over 5 years, their payout ratio is now at 59%).
P/E Ratio Vs. 5 Year Income Growth
The last quadrant (but not the least) compares the P/E ratio with 5 year income growth. It’s like comparing future assumptions with past results.
The P/E ratio is the current evaluation of a stock by the market – the future assumptions. A high P/E ratio means that the market is anticipating strong growth. You will more likely find overvalued stocks in this category (just think of RIM a few years ago). The historical P/E ratio of the S&P 500 is 16. Anything over 20 means the market is pricing in a great deal of growth making the stock much riskier for decline in the event of a disappointment.
On the other side, a low P/E ratio is consistent with a stock evolving in a mature industry, or occurs when a stock is undervalued. It is obviously tricky to determine which stocks are priced correctly or not. Also, please keep in mind that the P/E ratio will be greatly affected by the stock market’s assumptions.
For example, after two years of deceiving financial results, RIM has traded at a P/E ratio as low as 3.81! This doesn’t mean that the company is undervalued; it means that the market doesn’t believe the company can keep up with its previous results!
This quadrant will help you find stocks with the lowest P/E ratio relative to the highest income growth. In other words, it helps you find growth without paying a premium.
| Ticker | P/E Ratio | 5 Yr Income Growth |
| T | 14.33 | 19.59% |
| CPB | 12.44 | 0.09% |
| HRS | 9.61 | 8.17% |
| AFL | 7.28 | 20.20% |
| MSFT | 11.9 | 11.21% |
| BMY | 15.07 | 6.41% |
| GIS | 16.04 | 6.29% |
| CVX | 8.13 | 7.21% |
| BLK | 17.29 | 23.02% |
| GRMN | 17.4 | 14.79% |
With this quadrant, look for stocks in quadrant #1 (low P/E ratio with positive income growth). Those stocks are more likely evolving in a stable environment (this is why their P/E ratio is lower) making them lower risk, but with income growth (so they are able to increase their dividends). Those types of companies will likely only become stronger over time:
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This quadrant highlights AFL as being the only stock with a high income growth and low P/E ratio. This is also related to the fact that AFL is evolving in the financial industry. Stocks like BMY and GIS are quite deceiving because they are trading at higher P/E ratios without showing strong income growth.
This quadrant will help you choose stocks in terms of their past growth showing how much you are paying for expected future growth. For example, GRMN had an interesting 5 year growth and is expected to grow in the future… unless the stock is overvalued. As long as you stay under a P/E of 20, you should be playing in a relatively safe playground.
Cross Referencing the Quadrants
Now that you know how to use the four quadrants, the most important thing is to use all four of them!
Don’t get complacent and use one or two comparative measures. Use all four of them to paint a complete picture. Don’t jump to a conclusion and don’t be afraid to look into financial statements once in a while to understand how a stock might be less attractive in one quadrant compared to the others.
By cross referencing the 4 quadrants, you will find certain stocks that keep showing up with desirable combinations of characteristics such as GRMN, BLK and AFL. While none of the 10 stocks are strong in all aspects, those 3 stocks have a better “batting average” than the others.
Other stocks might look promising based on the fact that they passed the screener and measured well on a couple different quadrants thus requiring deeper research to understand the inconsistencies. Stocks on the “to be researched further” list include CVX, MSFT and HRS. These are three mature companies leading their respective markets. They should be on your “stocks on the radar list” according to the screener and quadrant analysis.
Finally, you have other stocks that didn’t quality half of the time or more (T, BMY, GIS and CPB). I would just eliminate these because they miss the target on important metrics. It doesn’t mean that they are not interesting stocks, but when your goal is reliable dividend growth there are better purchases.
So out of 10 stocks and 4 quadrants, you have:
- 3 very interesting picks (GRMN, BLK & AFL)
- 3 “further research” picks (CVX, MSFT & HRS)
- 4 “not very interesting” picks (T, BMY, GIS, CPB)
Doing this exercise can require some time as you first need to put all of your stocks in an excel spread sheet, then find all the metrics and create your quadrants. In order to do it, here’s a very easy tutorial for excel users:
- Create a table as shown in this book (ticker, metric #1, metric #2)
- Select data only in metric #1 and metric #2 (the 2 columns)
- Click on “insert”, then “other charts” and select “X Y (Scatter)”
- You’ll get your points in a graph. You select Chart Layouts and take the circled one in the second line of options.
- Then, you simply have to print it and add the stock name besides each dot and you have your quadrant!
Using Dividend Stocks Rock to Facilitate Your Investing Process
If you are thinking, “Wow, that looks like a lot of work”, then you would be right.
Yes, it takes time and effort to first complete all the factor screening to create a dividend stock shopping list and then further sort for quality and consistency using company fundamentals and then quadrant analysis.
After teaching this method to many people the one consistent response was, “Interesting. I like it, but is there a way for me to just pay you to do it for me?”
And so that is why I’ve developed a membership web site that does exactly that. (Affiliate link.) If you want to do it yourself, you have all the knowledge you need in this article. I gave it to your freely. You don’t need me because this is the complete recipe. Nothing held back.
However, if you want someone to do all the screening and quadrant analysis for you then I’ve built a website that does exactly that by allowing you to:
- Search through my pre-screened stock lists,
- Monitor my model portfolio performance,
- Read my stock commentary every two weeks,
- Know exactly when any company in my model portfolio provides quarterly reports,
- Benefit from my unique stock ranking system.
You can get to this website here and it simply does what I taught you here at such a low price that it really doesn’t make sense for you to do it yourself. (Affiliate link.)
I hope you found the ideas in this article helpful for your dividend growth stocks investing strategy.
Please let me know your thoughts in the comments.
Here’s how to make more by losing less…
If you're looking for an investment strategy that goes beyond "buy and hold" while controlling risk and requiring as little as 30 minutes a month to manage, this is the answer. It’s so good I wish I had built it myself. Take back control of your portfolio and start getting results today.
Todd,
Dividend investing has become the big new trend now. Every where you look it is being offered. AAII, The Motley Fool, the Oxford Club and so on all offer their dividend Growth Strategy, and they present it as a strategy that will withstand the next big downturn. Of course they back test it and say it works wonders.
In this post Mike offers his experience over a very very short test period. He beat the market the past two years picking dividend stocks. But, so has everyone else because hey are the new “it” investment. Demand drives price, so of course dividend stocks will increase. When large caps lead, for example, all we hear about is ” get my proven large cap strategy, and sure enough it does well.
When interest rates increase, or the next bear is upon us, dividend stocks will get crushed. No type of stock leads for ever.
Mike needs a much longer period of success before he offers solutions. To be truthful, I’m surprised you are offering his plan considering he has no real track record.
Boomerst3 Let’s grab this comment piece by piece since you raise some important points.
I fully agree that two years is not a track record. You are 100% correct, particularly considering that the environment favored dividend stocks during that time period. These past few years were not even a good test.
During recent years artificially low interest rates created an environment that forced yield hungry investors to accept more risk to satisfy their income goals so they have aggressively bid up dividend stocks.
You are also correct in stating that during the next market downturn dividend stocks will go down with the rest of the market. 100% agreed.
The only valid risk management solution to the bear market problem is a sell discipline. Traditional diversification underlying any buy and hold strategy will not suffice.
In addition, investing according to a specific style (dividend or large cap or value or whatever) does not provide any risk solution for a bear market either since they are positively correlated – particularly in a downturn. The only solution to that problem is a sell discipline. Period.
With all that said, it does not in any way diminish the value of this article. The point in my mind in publishing this article was to provide a complete methodology for sorting high quality dividend stocks from low quality.
In that regard, Mike delivered in spades and I’m appreciative to him for sharing that methodology to help educate readers.
Please remember – this is an article – just one article. It has inherent limitations. 5ooo words are barely enough to properly develop a solid sorting criteria. I felt Mike did an excellent job in that regard and that is why I published this. I think it will help a lot of people who are just shooting in the dark.
Maybe in future posts we will develop sell criteria as well to round out what is a well developed offensive strategy (expectancy) with the defensive components (risk management) as well.
Boomerst3 Hello Boomerst3,
Dividend investing is not a trend, some investors have started dividend investing 30 years ago. It’s not because now we talk about dividend investing in the media that it is automatically a bubble that will burst. You can find several great dividend stocks with a P/E ratio under 17 right now.
I’m not convinced everybody beat the market in the past two years as you suggest. Several investors did well, I agree with you, but they didn’t beat the market by 11% as I did in 2013. I’ve started investing in 2003. From 2003 to 2006, I’ve borrowed 20K and made 70K with it in three years. This wasn’t through dividend investing but I’m saying I haven’t started investing last in 2012 either.
The only difference is that I started to publicly post my results on my blog in 2012.
I’ll come back in 5 years with a longer track record… and 2014 is on track to be my third year in a row to beat the market 😉
Cheers,
Mike.
Mike,
No disrespect meant but you have no track record. You invested from 2003-2008 and did well and now you did well the past two years. You started at the end of the tech driven bear market, right at the start of a new bull. Of course you did well. The last two years you did well in dividend stocks. So did the market in general. Maybe you haven’t noticed but because of low interest rates, demand for dividend stocks has been sky high. Because supply and demand drive the market, dividend stocks have done very well. There are many, many newsletters offering their dividend stock programs. This could very well be a bubble, especially when conservative investors pull out after interest rates rise in cd’s and bonds. It has nothing to do with talking in the media that will burst this bubble. It’s because so many newsletters are offering it and so many are investing in them.
II said everybody like you who is investing in the best dividend stocks is beating the market, not everybody in general.
Also, you say there are many stocks with PE’s below 17 implying there are many good stocks out there, so no bubble. Are you implying low PE means it has to go up? Do some research and you will see there is no serial correlation between PE and the direction of a stock and the market.
Also, and no disrespect here, you are a neophyte who has invested in two great bull markets, for what, maybe 6 years, going on 7? And now you are the Dividend Guy?
Come back after a couple of market cycles and let’s see how dividend stocks have done. That will be the litmus test
Boomerst3
I agree I don’t have a 20 years track record but it doesn’t mean that I don’t know what I’m doing. I don’t claim to be the next Buffett either.
There is a high demand for dividend stocks, but it’s not only due to low interest rate; companies are also making more sales and more profit and increasing their dividends. As you said, this is a bull market, everything is going up.
However, I don’t think interest rates will go back where it will be easy to buy a 5yr CD at 5-6% tomorrow. There is a very long run to do before we reach this level. In the meantime, dividend stocks will continue to perform well. I’ve looked at “popular” dividend stocks such as KO, JNJ, WMT, MCD historical P/E ratio and they are trading about the same value now that they were in the early 2000’s. So why would their price suddenly drop if they keep posting good financial results? The market is not driven by small individual retirees but it is driven by institutional traders such as banks, pension plans and other financials.
If you look at all bubbles, the average P/E ratio of the S&P500 is always around 20-22.There is definitely a link between the value and the fact that there is a bubble coming or not. I’m not implying low PE should go up, I’m saying low PE means they are fairly valued. A bubble happen when stocks are overvalued, not fairly valued.
If I come back after a couple market cycle, the price won’t be $14.95, it will be $495 per month ;-). My service is not only about my stock picking anyway, I also offer many pre-screened stock lists and a newsletter that goes through all stocks we follow to keep investors up-to-date after each earnings seasons so they don’t have to do the tracking themselves.
Thx for your comments, it’s a great conversation!
Mike
Boomerst3 Okay, enough! You state “no disrespect here”, and then you are completely disrespectful by declaring him a “neophyte” and telling him to come back in a couple of years.
That sounds completely like “disrespect” in my book and is not acceptable.
I published this post for one reason – to help people interested in dividend stock investing develop a fundamentally valid methodology for sorting quality from not. That point is being completely ignored in this discussion, yet that was the subject of the article.
Here’s the reality. A long-only dividend stock portfolio will lose money in the next bear market just like any other long-only stock portfolio. The only way to not lose money in the next bear market is to not be invested – i.e. a sell discipline – but that is not the subject of this article either.
With that said, numerous independent third-party research shows a properly selected, value based, dividend paying portfolio of stocks generally declines less than the overall market during bear markets (holds up better) and tends to outperform during bull markets.
That has nothing to do with Mike’s track record. It has to do with independent research on dividend stock portfolio modeling consistent with what Mike is sharing here.
While you are correct in stating that Mike’s track record would not hold up to traditional due diligence standards, that critique is not as important to me as the idea of whether or not the approach is fundamentally valid. All of the independent, third-party research that I’ve seen tells me Mike’s selection criteria are pointing in the right direction which I why I published this article. I think it will help people sort the wheat from the chaff.
I would like to challenge you in this discussion to refocus your clear intelligence and well-developed background into adding value instead of tearing down.
For example, you completely missed the opportunity to show the declining role of dividends over the historical data and the rising importance of the total payout ratio as a selection criteria as evidenced by the work of Mebane Faber and other researchers/money managers.
Subjects like this would allow you to honor your historical pattern of negating the current conversation while still adding value to the discussion.
In short, I appreciate your intelligence and knowledge about investing which is why I allow your comments (even when they are disrespectful). However, I’m asking that you focus your intellectual capability on adding value rather than tearing down.
One of the principles I teach is that there is no perfect investment strategy – including this one. Every investment strategy has an Achilles Heal – including what Mike is sharing here.
The Achilles Heal to a long-only dividend stock strategy where the only sell criteria is fundamentals (see Steve Juetten’s comment thread in this discussion) is that it will participate in the ride down in bear markets.
The fact that every investment strategy has an Achilles Heal creates a perfect environment for someone, such as yourself, to negate every strategy because the Achilles Heal can always be identified.
The problem is that serves nobody.
The reality is real world investors must place capital at risk into an unknowable future in an imperfect world using imperfect methods – including this one.
Mike has provided an excellent tutorial on how to sort dividend stocks based on fundamentals for those investors interested in dividend stock investing. I firmly believe his criteria can help most dividend stock investors which is why I published this post.
I would like to ask that you direct your comments to adding value to best practices for the subject of this tutorial guide instead of taking the negative path and tearing down the author.
Thanks for sharing your model with us Mike. Curious about one thing: when do you sell a stock that you’ve carefully chosen using your methodology? Thanks.
Steve Juetten
smjuetten I put an email over to Mike to try to get him to join the discussion and share the sell side/risk management side of the methodology since it seems to be a recurring theme in these comments so far. Thanks for asking…
smjuetten Sorry for the delay, I was on a short trip since Saturday with limited access to a computer.
The reason I sell is directly linked to the reason why I bought a stock in the first place. If the company fits my model, I will buy it and keep it as long as its metrics are in line with my investing philosophy. This means I could keep stocks for 5, 10 years if it continues to post strong results.
On the other side, if a company seems to have a hard time to grow its sales for example, I will dig deeper to see if this is a strong trend or just a bad quarter. This is how I sold Seagate Technology (STX) after a great run of 72%. The company didn’t seems to keep up in the mature (read obsolete) market of hard disk. They have an opportunity with cloud computing but I rather sell with profit and see what happens next.
cheers,
Mike
Thanks for the model Mike! The article can definitely be a vital source of information when going after passive dividend income. I’m only 15, but my goal is to become a business owner, own real estate, and other income producing assets so I can design the lifestyle I dream of.
I’ve always been interested in the selection process of dividend stocks. It’s great that you let us pick your brains on here.
Todd~ Boomerst3 raised a good point in saying that dividend stocks are being really hyped up as the big thing right now. The Oxford Club sends me emails about them virtually everyday that tout impressive returns, but by the next downturn ALL stocks will take a hit. I’m a big believer of diversification, but not in the typical sense of buying a wide variety of stocks. I believe that paper assets aren’t really a “wealth generator” in the same way businesses and real estate are, but are great to supplement your income and further expand your wealth. The fat cats on wall street usually own funds that have assets under management that create wealth for them (these are businesses after all).
You are a 1000% right in saying the good ol’ buy, hold, and sit on your hands won’t suffice in this “new” market. “This ain’t your daddy’s stock market.” is a good quote I like. What exactly is sell discipline? Are you referring to knowing when to sell and keep good returns and not to get greedy and hold on wait for even more gains. The tech bubble back when I was an infant is a great example of people who lacked sell discipline in that definition of the word. Please elaborate.
Thanks in advance Todd and Mike!!!
John Elmenhe Hello John,
thx for your comment. Dividend investing won’t shelter you from the next market crash but dividend stocks will always be less affected than other type of companies during recession. By definition, a good dividend stock has been increasing its payout for several years in a row (aristocrats has done it over 25 consecutive years!). Those kind of companies can increase their dividend year after year because they have the ability of increasing their sales and profit. In other words, they have a sound business model that goes through bear markets and market crashes. Dividend investing is not the “new thing”, it is a way to invest for life.
Agreed. Dividend stocks are nothing new and In my mind they’re better than investing for growth. Dividends with moderate growth that (dividends) are reinvested can be a huge wealth creator or serve as a source for passive income… I was just saying that the Oxford Club is OBSESSING over them.
Do you reinvest your dividends Mike? Also, do aristocrats remain aristocrats? I’ve learned a bit about them, but even in a bear market do they raise dividends?
Thank Mike!!
John Elmenhe It is true that there is an overload of newsletter talking about dividend stocks right now. It’s only normal; they are going after the retirees 🙂
I don’t reinvest my dividends right now as I’m still growing my portfolio. At one point in time, I will definitely use DRIPs.
To be classified as an aristocrats, you must increase your dividend each year. Therefore, if a company stops growing its dividend, it will be taken off the list.
Here is a recent article from Forbes. Note the info on dividend payers in the last bear market:
11/12/13
What Could Possibly Go Wrong?
As with all businesses, lots of things can derail dividend-paying companies. However, these are the things that tend to blindside investors.
Dividend Cuts: In the challenging last quarter of 2008 alone, 288 companies cut dividend payouts, according to Standard & Poor’s. By the end of 2009, another 804 dividend payments were cut by public companies in 2009.
Lessons: Stocks paying dividends are not guaranteed; the company’s board chooses whether or not to pay out cash dividends to shareholders. Also, note that not all dividend cuts are signs of looming financial catastrophe. Pfizer (NYSE:PFE), for instance, cut its dividend in half to fund its acquisition of Wyeth. Another action a company might take is to repurchase shares instead of increasing the dividend.
Dividends on borrowed time: While 2008-2009 proved that even financially sound companies can choose to circle the wagons and preserve cash, it’s fair to say that most dividend cuts happen for other reasons.
Dividends are paid out of cash, and if the company lacks cash it will have to fund the dividend either through debt or selling stock, neither of which is sustainable.
Boomerst3 Your Forbes post is exactly why I published this article. Many people are interested in dividend stock investing to create sustainable income. The key is being able to sustain the dividend which necessitates pursuing fundamentally sound companies which is exactly what Mike’s sorting techniques seek to identify.
Will it be perfect? Of course not, because there is no perfect solution in investing. It is always and forever a probabilistic reality, and Mike’s fundamental analysis approach soundly places probabilities on your side.
See my comment to your thread below as well…
Would you consider investing in all or mostly aristocrats a great way to build wealth? Also, what are some example yields one could expect? I’m assuming they’ll be lower.
John Elmenhe Hello John,
This may not be a good investment strategy as being an aristocrats doesn’t give you any guarantee for the future. However, it is a good start to look for fewer stocks at first. You can find low yield (1-2%) up to 5%. AT&T is on the list at over 5% div yield. I’m not saying it’s a good investment, but you can find some good yield even in this list.
Keep in mind their dividend increases each year, if you buy a 2.5% yield stock, it could rapidly become 3.5-4% based on your cost of purchase.