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Selecting Dividend Stocks With The Dividend Analyzer: How It Works

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Selecting Dividend Stocks

Selecting dividend stocks can be difficult and time consuming. The Arbor Dividend Analyzer provides a time saving approach to discover, evaluate, and compare dividend stocks without emotional bias.

The Arbor Dividend Analyzer is a comprehensive spreadsheet with 30+ quantitative and qualitative metrics from my dividend checklist.  We take the most important and consequential metrics (the database includes the top 254 dividend paying companies) and break down each stock into a Profitability & Growth Score, a Dividend Safety Score, and a Valuation Score. Each of these make up one-third of the Total Score for the stock.

Keep in mind there is no perfect set of metrics. However, I carefully picked these metrics individually and, more importantly, as a group. Combined they provide key insights into the important areas of selecting dividend stocks.

The great benefit of the Arbor Dividend Analyzer is that you can quickly find and compare dividend stocks with out any emotional bias. The combined Total Score provides a solid quantitative approach with which to compare multiple stocks.

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Dividend Yield

Dividend Yield = Current Dividend Annualized / Stock Price

I prefer to stay between a 2% and 5% dividend yield. If a stock yields less than 2% I want to know if it’s because the stock is overpriced or if and why the company is not returning enough to shareholders.

If a stock yields more than 5% I want to have a clear understanding of what negatives are causing the price of the stock to be low. Does the high yield compensate the shareholder for whatever perceived risks are in the price of the stock?

Dividend Yield

The following sections: Dividend Safety, Profitability & Growth, and Valuation; provide a well rounded view of the important metrics to consider before deciding whether to continue further research of a particular dividend stock. The maximum score for each individual metric is in parenthesis with a total maximum score of 100.

 

Dividend Safety Score

The objective of the Dividend Safety Score is to measure the safety of a company’s current dividend and provide a score that can be compared with other companies.

 

Cash Flow From Operations (CFO) Dividend Coverage Ratio (6 points)

Calculation:  Cash Flow From Operations (CFO) Per Share   /    Dividends Per Share (DPS)

Cash Flow From Operations (CFO) measures the cash generated from the core business or operations of the business. The CFO Dividend Coverage Ratio compares the dividend to the amount of cash flow from operations.

In the long run cash flow from operations must supply the capital needed to reinvest in the growth of the company (research & development, and capital expenditures) and return capital to shareholders (dividends or stock buybacks).

The greater the coverage ratio the lower the probability that the dividend will be reduced by the company.

 

Free Cash Flow Dividend Coverage Ratio: (6 points)

Free Cash Flow (FCF) = Cash Flow From Operations – Capital Expenditures

Calculation:  Free Cash Flow Per Share /  Dividends Per Share

In the long run a company cannot pay dividends or improve the balance sheet without free cash flow. Free Cash Flow is the funds left over after all the bills are paid and capital expenditures. The FCF Dividend Coverage Ratio compares the dividend to free cash flow.

The greater the coverage ratio the lower the probability that the dividend will be reduced by the company.

 

Net Financial Debt to Total Assets Ratio: (12 points)

Net Financial Debt =
Financial Debt (Long Term Debt + Current Portion Debt + Dividends Payable + Notes Payable)
– (minus) Cash and Short-Term Investments

Comparing Net Financial Debt to Total Assets tells us how much the corporation’s assets are leveraged after accounting for their liquid assets.

The higher the ratio the more leveraged the company and the greater the probability of adverse conditions affecting the dividend in a negative manner. A negative number means the company has more cash than debts. Everything else being equal, these companies carry less risk of dividend cuts.

 

Piotroski F-Score: (9 points)

The Piotroski F-Score is made up of nine components. A pass is worth 1 point and fail worth (0). Here are the components grouped in order: Profitability, Capital Structure, and Operating Efficiency.

Net Income > 0
Cash Flow From Operations > 0
Higher ROA Than Previous Period
CFO > NI

Decline in Long Term Debt
Higher Current Ratio Than Previous Period
# of shares of stock < Than Previous Period

Higher Gross Margin Than Previous Period
Higher Asset Turnover Than Previous Period

Note that 6 of the 9 components are trending metrics. This makes the Piotroski F-Score a volatile but sensitive indicator of a company’s current direction.

I deliberately have the Piotroski F-Score in the Dividend Safety section because the score can move fast (up or down). Low scores could be an early indicator of possible future problems. Conversely, high f-scores would mean a low probability of a dividend cut.

The F-Score has a proven record as an indicator for a company’s future stock performance. Groups of stocks with a 7, 8, or 9 far outperform groups of stocks with a 0, 1, 2, or 3.

Total Dividend Safety Score: (33 points)

 

 

Profitability & Growth Score

The objective of the Profitability & Growth Score is to measure and compare the Profitability and Growth of a company and provide a score that can be compared with other companies.

Revenue 10 Year Compounded Annual Growth Rate (*CAGR) > 4.14%**: (4 points)

I prefer (all else being equal) to own companies whose earnings and revenue are growing close to the same rate.

If a company’s revenue is growing slower than its earnings growth rate, it is a warning that the company may not be able to continue its past earnings growth rate into the future. It may mean that they have used efficiencies to increase profitability. While this is positive for the historical period, it may indicate an unsustainable earnings growth rate.

If a company’s revenue is growing faster than its earnings growth rate, it gives me a red flag that the company has falling profit margins. It may be facing intense competition, higher input costs, or changing its product mix.

If I choose to do further research I would want to know why the two ratios are different. Either way, I would assume the company might be able to grow at the slower of the earnings or revenue growth rate.

 

EPS Basic From Continuing Operations 10 Year CAGR => 4.14%**: (4 points)

When selecting dividend stocks I want to own companies that have proven they can grow operating earnings at a satisfactory rate for a long period of time. A company cannot raise its dividend faster than its earnings in the long run.

A company that grows at 4.14% for 10 years will increase earnings 50% every 10 years. A 4% growth rate on top of a 3% dividend yield will provide a long term total return of 7%. I’m going to look unfavorably at any dividend growth stocks that haven’t proven the ability to at least achieve this minimal return.

Cash Flow From Operations 10 Year CAGR > 4.14%**: (6 points)

While revenues and earnings are important, a company must create cash flow from operations in order to reduce debt, re-invest for future growth, or return money to shareholders. If, in the long run, cash flow from operations cannot be increased by at least 4.14% I’m probably not interested in making an investment in the company.

*Compound Annual Growth Rate (CAGR)
**A Compound Annual Growth Rate of 4.14% = a 50% gain over 10 years.

Operating Earnings Yield (OEY): (7 points)

Operating Earnings Yield = Operating Earnings (TTM) / Market Capitalization

Operating Earnings Yield is one of my favorite metrics because, by using market capitalization as the denominator, it compares operating earnings to the price you are paying for the stock (or the current price). The price today is what really matters to you as an investor. Therefore, I think using market capitalization is superior to metrics that use shareholder equity as the denominator.

In addition, the numerator uses operating earnings, instead of net income, which removes much of the “noise” from the metric. In other words, operating earnings excluding taxes, non-operating income and expenses, discontinued operations, extraordinary items, etc. Many analysts feel this is a more accurate view of the company’s ability to create earnings.

Gross Profitability = Gross Profit to Total Assets: (12 points)

Gross Profit to Total Assets = (Revenue – Cost of Goods Sold) / Total Assets

Gross Profitability is a profitability and efficiency ratio researched by Robert Novy-Marx to identify stocks that outperform the market in the long run. It measures the amount of profit a company generates for each dollar of total assets.

This metric is gaining popularity in value investing circles. You can find an outstanding explanation of this ratio in Deep Value by Tobias Carlisle, pages 194-195. By the way, I highly recommend this book for those who are interested in quantitative value investing.

Total Profitability & Growth Score: (33 points)

 

 

Valuation Score

The objective of the Valuation Score is to measure and compare the valuation of the company stock and provide a score that can be compared with other companies.

 

Free Cash Flow Yield (FCFY): (9 points)

Free Cash Flow Yield (FCFY) = Free Cash Flow / Market Capitalization

or

Free Cash Flow Yield (FCFY) = Free Cash Flow Per Share / Stock Price

Free Cash Flow Yield (FCFY) provides the relationship between the stock price and the amount of cash that is left over from operations after the company completes its capital expenditures. Another way to look at it is that Free Cash Flow is the money available to pay dividends without using reserves or borrowing.

This is a key metric because it tells you a great deal about the health of the company AND the valuation of the price you are paying for the stock. In other words, it indicates the percentage return of free cash flow the company is generating compared to the price of the stock.

 

Enterprise Value Multiple (EV to EBIT): (9 points)

EV to EBIT = Enterprise Value / Earnings Before Interest & Taxes

This is one of the most widely used and important valuation metrics in investing. In general, the lower the number the better. I prefer to find stocks with a multiple below 10, but use 15 as a first screen.

Enterprise Value to EBITDA: (9 points)

EV to EBITDA = Enterprise Value / Earnings Before Interest Taxes Depreciation & Amortization

The fact that the EV to EBITDA ratio adds depreciation and amortization back into the earnings denominator means this ratio will almost always be the lowest of the EV ratios. This ratio is gaining in popularity among value analysts. It is particularly valuable when combined with the other metrics that make up our value score.

If you don’t have a clear understanding of Enterprise Value ratios I suggest reading: Enterprise Value (EV) & Calculating Enterprise Value Ratios.

PE10: (7 points)

PE 10 = Stock Price / Average Earnings Per Share (EPS) Over the Last 40 Quarters

Benjamin Graham touted using long term averages of earnings to smooth out fluctuations. This provides a more stable metric with which to compare to price.

Dr. Robert Shiller popularized the Shiller PE10, also known as Cyclically Adjusted Price-Earnings (CAPE). Historical evidence demonstrates that baskets of stocks bought with a high PE10 provide lower rates of return than baskets of stocks bought with a low or reasonable PE10.

 

Total Valuation Score: (34 points)

Stay Updated All the Time!

 - Monthly Stock Rankings and Dividend Safety, Profitability & Growth, & Valuation Scores for all 280+ DVB Stocks - Dividend Value Builder Full Membership =>  $99/year (Analyzer & Portfolio Newsletters) Two Newsletters For 1 Low Price

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Total Dividend Analyzer Score

The Dividend Analyzer total perfect score would be 100. The average in the Arbor dividend stock database (254 stocks) is approximately 50. This gives you a reference point when comparing different stocks. Scores above 50 are above average, and scores below 50 are below average.

The total score takes into account quantitative and qualitative metrics from the Balance Sheet, Income Statement, and Cash Flow Statement. They are combined in different ways (ratios) so that they present the metrics that are important and predictive to paying and growing dividends for shareholders.

The great benefit of the Arbor Dividend Analyzer is you can quickly discover, evaluate, and compare dividend stocks without any emotional bias.

Discover, Evaluate, and Compare Dividend Stocks

Dividend Analyzer Newsletter: Analyze Dividend Safety, Profitability & Growth, and Valuation without emotional bias (All DVB Stocks by Total Score and Sector). DVB Portfolio Newsletter => Three DVB Portfolios: Foundation Portfolio, Dividend Growth Portfolio, and High Income Portfolio. Get BOTH Dividend Value Builder Newsletters for $99/year. Free 10-Day Trial. You take NO risk. Start today!

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Disclaimer: While Arbor Investment Planner has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, or completeness of third-party information presented herein. The sole purpose of this analysis is information. Nothing presented herein is, or is intended to constitute investment advice. Consult your financial advisor before making investment decisions.
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