The following is a guest post written by Mike from The Dividend Guy Blog and Dividend Stock Analysis. Mike has an MBA in financial services and writes about dividend investing since 2010. His goal is to use dividend growth power to retire early.
When I was a kid, I always wanted to work in the investment industry. I had a grand perception of the financial industry and thought it would be so cool to be able to buy shares of big companies such as Coca-Cola or Nike. I also liked the fact that many investors were riding around in their BMWs and living the good life. Obviously, this was the perception of a 15 year old looking at a one sided coin. The other side of the coin was completely unknown to me; I’m talking about the hard and boring work that stock analysis requires. They never say how many hours successful investors spend on financial statements and making calculations!
Investing is fun, but it has to be done through a strict process if you want to become successful. In this post, I’ll be sharing my investment process that combines strict metrics along with some areas where you can cheat.
Stock Metrics That Don’t Lie
There is nothing easier than finding dividend paying stocks. The key is to find strong stocks that will continue to increase their dividends over time that you don’t have to sell one year after buying it! In order to do so, there are some key metrics I use prior to selecting a great stock.
Using the TMX stock screener, you can use my technique as is. It’s a Canadian stock screener but you can also get stock filter results on US markets. I like to keep things simple so I don’t use too many metrics; only a handful to gather solid data:
- 5 Year Annual Income Growth Rate: between 1 and 100 (if sales don’t go up, dividend growth will eventually be jeopardized).
- Current Dividend Yield: over 3% (I think 3% is reasonable in the current economy. I sometimes cheat and look for over 3% in the hopes of picking a gem with a 2.75% dividend yield).
- Return on Equity: Over 10% (I want companies that use my money to create wealth. Keep in mind that you’ll need to look inside each financial statement to see if the ROE is stable over the years).
- 5 Year Annual Dividend Growth Rate: Over 1% (I’m looking for companies with a dividend growth strategy)
- Current Price Earnings Ratio: Under 15 (I sometimes cheat and take it up to 20 ).
Another metric I would use is to find companies with dividend payout ratio under 75%. I want to make sure the company has still room to increase its dividend in the future. High payout ratios will eventually lead to dividend yield stagnation or worse; a dividend cut! Unfortunately, the latter is hard to find within free stock screener. This is why I calculate it separately most of the time once I’ve picked a few stocks to look at.
Consistency is Better than Double Digit Numbers
When it’s time to pick the “right” stock, I prefer a company showing consistent numbers than hectic years with an overall impressive growth. For example, I would rather buy a company showing a dividend growth history that looks like this:
Than another company with hectic results:
When you look at both graphs, both companies have increased their dividend over a long period of time. The thing the % doesn’t tell you is the consistency of the dividend growth. It’s a little bit more work but doing this graph will tell you that company A has a stronger dividend than company B which had to drop it after the 2008 crisis.
When you look at financial statements, pick-up the “highlights for investors” or go through the first pages of the last annual report. You will usually be able to find similar graphs showing Earning per Share, Sales and Dividend growth. If you can find companies constantly going up, you have a winner in your hands.
Look at the Future
The stock screener will give you a good idea of the present while the graph will explain the past. The future of a company is also very important since you can’t get a cut on the previous years as you didn’t own the stock.
Looking at both the sector and the specifics of the company will say enough to tell you if there is a future for it or not. It’s important to identify worst case scenarios more so than positive ones. You can decide you go with steady and slow companies such as JNJ or KO or you can take more risks with techno stocks for example. It’s much easier to predict the future in the beverage industry than with processors and smartphones!
Investing Requires Discipline
I’m not going to lie; if you want to manage your own portfolio, you will be required to be disciplined and setup a proper investment process. This doesn’t mean that you can’t save time while picking your stocks. I’ve discovered that once you have taken the time to setup your own way of investing, decisions are a lot easier to make.
For that reason, I’m providing over 200 stock analyses over on my new site: Dividend Stock Analysis. This is a good starter for someone who’s looking for a second opinion!