Selecting Dividend Stocks With The Dividend Value Builder: How It Works
Selecting dividend stocks can be difficult and time consuming. The Dividend Value Builder provides a time saving approach to discover, compare, and evaluate dividend stocks without emotional bias.
I analyze companies with fundamental quantitative analysis to estimate an intrinsic value range. This provides us with a margin of safety estimate and estimate of forward returns if the company stock gravitates toward its intrinsic value over time.
Each of our stocks is evaluated and receives a Risk Stability Grade, Dividend Safety Grade, and Earnings Quality Grade. This allows us to decipher some of the strengths and weaknesses of each company. The Risk / Stability grade in particular allows us to differentiate stocks in risk categories.
Our intrinsic value / margin of safety analysis eliminates the companies with unfavorable stock prices. This allows our members to concentrate on stocks that offer a margin of safety and a more favorable risk/reward ratio. This is regardless of whether the individual stock is in a low or high risk category. We compare our intrinsic value to the current price and look for bargains in all risk categories.
How to Use the Dividend Value Builder
Our objective is to find dividend stocks that can provide above average rates of return. The best and safest approach is to find stocks that are priced below the real or intrinsic value of the company and therefore provide a margin of safety. The difference between the current stock price and the intrinsic value is the margin of safety.
My intrinsic value analysis concentrates on cash flows; particularly cash flow from operations and free cash flow. Unlike earnings, cash flow metrics can’t be manipulated or distorted.
Each stock is assigned a Risk / Stability Grade. Risk adverse investors should concentrate on stocks with A, B, or C grades. Investors with diversified portfolios seeking above average returns would include stocks with a D or F grade also.
Here are some of the main factors and metrics I consider in determining intrinsic value:
Dividend Yield = Current Dividend Annualized / Stock Price
Historically approximately one-half of long term stock market returns are delivered through dividends. Dividends are real, they can’t be faked or brought about by fraudulent accounting.
If a stock has a low yield 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 yield is high 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 risks are in the price of the stock?
Analysis Grades and How They Are Used
Risk / Stability Grade
The Risk Stability Grade is a classification of the overall environment of the given company including the economy, company sector & industry, balance sheet, dividend safety, earnings quality, competitive advantages (or lack of), perceived moat, etc.
A grade indicates a quality company with a strong balance sheet, high earnings quality, and a positive business environment. These stocks require the slimmest margin of safety within the stock universe.
B grade indicates a company with a good balance sheet, good earning quality, and a stable business environment. The margin of safety required should be greater than stocks with an A grade but less than the average stock.
C grade indicates a company with a sufficient balance sheet, at least average earnings quality, and a reasonably stable business environment. The margin of safety required is greater than A & B stocks, but less than D & F stocks.
D grade indicates a company in good standing but has issues that could affect its stability and long term risks. D rated stocks should require a large margin of safety when purchased.
F grade indicates a company with significant issues that are currently affecting its stability and long term risks. Require an extremely large margin of safety for F rated stocks when purchased.
Dividend Safety Grade
The objective of the Dividend Safety Grade is to measure the safety of a company’s current dividend. Factors include dividend yield, number of years paying a dividend, how often the dividend is increased, and consecutive years of dividend increases. Particular attention is given to the Cash Dividend Payout Ratio and Net Financial Debt to Total Assets Ratio.
A grade indicates an extremely low probability of a dividend cut. This rating is reserved for companies with strong balance sheets and/or excellent dividend histories.
B grade indicates a low probability for a dividend cut.
C grade indicates a low probability for a dividend cut with only small safety risk issues.
D grade indicates there are issues that should be considered concerning future dividend payments.
F grade indicates serious dividend safety risks. Investors should complete comprehensive due diligence before investing.
Cash Dividend Payout Ratio:
We use the Cash Dividend Payout Ratio because it is a far superior metric than the commonly used payout based on earnings. The cash dividend payout ratio takes into account the cash required to fund capital expenditures and preferred dividends, both of which need to be paid before the common stock dividend.
In addition, the cash dividend payout ratio uses cash flow from operations; a metric that can’t be manipulated (as reported earnings often are). We want to insist on safety but also pursue dividend growth. A low cash dividend payout ratio gives us the potential for both safety and the ability for the company to grow the dividend.
Net Financial Debt to Total Assets Ratio:
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. Net financial debt is more accurate and more important than ever because of the corporate trend to leave cash overseas and borrow domestically.
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.
Earnings Quality Grade
The objective of the Earnings Quality Grade is to measure profitability and efficiency of a company’s earnings. Particular attention is given to the Gross Profitability Ratio and the Piotroski F-Score.
A grade indicates earnings quality is high or far above average.
B grade indicates earnings quality is good or above average.
C grade indicates earnings quality is acceptable or average.
D grade indicates earnings quality is poor or below average requiring thoughtful due diligence.
F grade indicates the quality of the earnings is poor or far below average requiring serious due diligence .
Gross Profitability Ratio
= Gross Profit to Total Assets:
Gross Profit to Total Assets = (Revenue – Cost of Goods Sold) / Total Assets
Gross Profitability Ratio 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.
We want to buy stocks at bargain prices, but we want to buy quality companies. The Gross Profitability Ratio uses gross profit (the basics of what a company does) and matches it with the amount of assets required to produce the profit. This is a high probability metric for indicating companies with sustainable competitive advantages.
A high Gross Profitability Ratio is evidence that a company has sustainable competitive advantages. Otherwise competition would enter their market and lower their profits. The fact that they have above average profits means they are able to achieve a premium or favorable position over their competitors.
The Piotroski F-Score is a 9 point ranking system with an incredible performance record of finding investments with good fundamentals and eliminating stocks of weak companies.
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
Number 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.
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.
Ideally we want to find companies whose stock price offers an opportunity to purchase when the odds are heavily in our favor. In other words, we look for bargain prices. The Dividend Value Builder allows us to examine the appropriate metrics without the emotional bias that we all have when looking for stocks that we “like”.
Many times the most “unpopular” stocks are the best opportunities because they they have a favorable price. We initiate our research with “blinders” on. Our quantitative analysis allows us to discover, evaluate, and compare stocks without emotional bias. Our three DVB Newsletters will assist you in finding the best stock opportunities for your portfolio! Each newsletter covers the stocks in our popular real-time AAAMP Portfolios.
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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.