My Approach to Dividend Investing

Following is a guest post from Devin, blogger at Dividend Chimp.

Devin A. Decker, Esq.

Bio: Devin is an Estate Planning Attorney and Dividend Growth Investor.  He has been helping individuals plan for retirement since 2002.  Devin writes about his options trades and provides dividend stock research services at his website: DividendChimp.com

My Approach to Dividend Investing:

I work from the most static to the most dynamic information, this means I start with relatively stable data and move onto information that changes more frequently. I’ve found this to be the most efficient way to track stocks.

Stock prices are in constant flux, this means that Dividend Yield, Price to Earnings Ratios (P/E), Price to Earnings Growth (PEG), and Price to Earning Growth plus Dividend Yield (PEGY) are constantly changing with the stock price.

It may be tempting to jump straight to yield and quickly discard a stock that doesn’t meet your minimum dividend yield criteria.  However, you could miss a great company that raises its dividend 50% next quarter because it wasn’t on your watch list.

On the flip side, don’t too get excited about a high yield stock without checking its dividend history first, you may see the dividend goes up and down from quarter to quarter with no stability.

I prefer to start with data that changes yearly, then the data that changes quarterly, and lastly the data that changes daily (sometimes by the minute).

Consecutive Years of Dividend Increases

I begin with the number of consecutive years of dividend increases because this information changes infrequently. Personally I prefer a minimum of 10 years of consecutive dividend increases, this tells me that the company was stable enough to increase its dividends through 2008 and 2009.

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Dividend Safety

Next I confirm the yearly dividend increases are sustainable by examining the dividend payout ratio (the percentage of the company’s earnings paid out as dividends).  While a low payout is preferred, somewhat higher ratios are acceptable for companies with consistent earnings.  More on earnings later, but in terms of payout ratio, the dividend can be considered relatively safe if earnings are consistent.  Payout ratio is also relative to the sector and industry. For example, utilities have relatively stable earnings and higher payout ratios than the energy sector, which has unpredictable earnings.

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Sample Report from dividendchimp.com

Dividend Growth

In terms of dividend growth, I’m looking at the 5 year average growth and the year over year percentage growth of the dividend. Ideally, I like to see the percentage increasing yearly or at least remaining stable. 

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Sample Report from dividendchimp.com

Stock Health and Growth

Next, I move on to quarterly reports, reviewing earnings, revenue, debt, and cash flow.

Before getting too concerned about what the stock is yielding or it’s P/E ratio, I want to make sure the company is healthy.  For me, this means growing revenue and earnings with stable cash flows.  Companies have bad quarters and often this can be a buying opportunity for long term dividend investors. However, quarter after quarter of declining revenue and earnings could be dangerous, especially if coupled with increasing debt and/or no cash flow growth.  Below: (LEG) is an example of a healthy company.

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Valuation

Once I’ve looked at years of consecutive dividend increases, dividend safety, dividend growth, and company health, I can determine if it’s a stock I want to own.

It doesn’t matter how high the dividend yield is, I don’t invest in anything that I wouldn’t feel confident holding onto should the market turn on me the day after I bought it.

Once I’ve determined it’s a company truly I want to own, I then decide what I’m willing to pay.  This is the longest and most involved process and unfortunately it’s too long to detail in a blog post, however I’m going to hit the highlights of what information I use to determine buy targets.  If you would like to read about my selection process in more detail, you can download my free eBook “Seven Simple Steps to Dividend Growth Success” at dividendchimp.com

Dividend Yield

Now is the first point I will look at dividend yield. My goal is a 5 year average dividend growth and a dividend yield, that when combined, equal at least 10%  This allows higher dividend growth rates to compensate for lower dividend yields (typically younger growing companies). It also allows larger, more stable companies with lower growth to compensate with higher dividend yields.

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P/E, PEG, PEGY

To quote Warren Buffett “Price is what you pay, Value is what you get.”  I want to know exactly what I’m paying for earnings (P/E), earning growth (PEG), dividend yield, and earnings growth plus dividend yield (PEGY).

P/E shows what we are paying in exchange for the company’s earnings, PEG shows what we are paying in exchange for the company’s earnings growth, and lastly, PEGY shows what we are paying in exchange for the company’s earning growth and dividend.

I calculate these ratios and compare them to competition in the same sector and industry as a benchmark. Lower P/E ratios (P/E, PEG and PEGY) provide better value. Yield is calculated as part of PEGY.

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Sample Report from dividendchimp.com

Current Multiples vs. 5 Year Averages

Using the 5 year average price ratios we can see how much investors have been willing to pay in exchange for a stock’s earnings, sales (revenue), cash flow, dividend yield, and book price.  This helps determine if the stock is trading at a discount or a premium to it’s five year averages.

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Fundamental and Technical Analysis

Combing Fundamental and Technical Analysis, we can see the range a stock has been trading in and where analysts expect it may trade, based on growth, forward P/E, and EPS estimates.

For the sake of brevity, I going to use just one example of the analysis used in determining buy targets:

How much have investors been willing to pay for a stock’s earnings?”

We often see a disparity between fundamental analysis (the price a stock should be) and what people have been willing to pay.

Example:  A stock’s price is $50, with earnings of $2.00/share, therefore its P/E is 25x earnings. If earnings rise to $2.50 per share, the P/E would drop to 20x earnings. ($50 price / $2.50 earnings = 20x P/E). How much will people be willing to pay now?

It’s likely that investors will be willing to pay up to $62.50 now that earnings have increased and there are two main reasons why:

Investors have been willing to pay 25x earnings. With an increase in earning to $2.50 per share, a P/E multiple of 25x would equal a new price of $62.50 per share.         ($2.50 earnings x 25 P/E = $62.50)

Increases in earnings build confidence and continue to fuel the upward trend. 

Momentum is a powerful force in stock prices.  Positive earnings results lead to positive future estimates by analysts and positive momentum often compounds onto itself. After determining what investors have been willing to pay, we can factor in pull backs from forward earning per share pricing in terms of percentages for discounted entry points. These pull backs can be used as one of the factors in determining buy targets.

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Earnings and Momentum

Next, I look at earnings and momentum. Earning reports and momentum aren’t just for day traders.  Long-term dividend investors can benefit from following a company’s earnings and price momentum.  One missed earnings quarter can provide a buying opportunity or “dip”, but several quarters of declining revenue or earnings may signal the company is in trouble. Check the earning report before buying, don’t automatically buy because the price drops without investigating why the price dropped. 

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Last, I watch Momentum trends for optimal entry points, we’ve all bought a discounted stock only to see it go lower and lower.  Paying attention to a stock’s momentum can help us find entry points where support has formed and market sentiment has turned positive.

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That’s an abbreviated summary of the steps I follow when evaluating stocks.  I collect roughly 130 pieces of information for every stock and format this information in a Stock Report so I can easily compare stocks. I then make a separate dividend report, earnings report, and lastly I grade the stock on its dividend, growth, value, momentum and short term outlook.

If you would like to read about my selection process, you can download my free eBook “Seven Simple Steps to Dividend Growth Success” at dividendchimp.com 

Thank you Sabeel (Roadmap2Retire) for inviting me to guest post on your blog.

Best,

Devin

11 thoughts on “My Approach to Dividend Investing

  1. Thank you Devin for sharing your stock analysis procedure. Speaking as rookie in the matter I must give you credit for being so pedagogic. I will definitely look into your eBook.

    – mraitn

  2. Hi mraitn,

    I consider that to be a great compliment. My goal is to provide members and readers with as much information as possible and to teach them how to take the information and make informed decisions. I think you will like the eBook. I really walk readers through my process in a very detailed way. The eBook is about 30 pages because of the detail involved. I don’t want to take for granted or make any assumptions on what a reader does or doesn’t know yet. If you have any questions about the eBook, or in general, feel free to contact me at DividendChimp.com or say “hi” on Twitter @DividendChimp.

    Thanks for reading,
    Devin

  3. My 20 year old self would have appreciated this information. “The soil stay wet longer with heavy rain”. Your way of evaluating a company is concrete, simple and effective. I might have to create a formulae for when I pull the trigger, i have all the numbers plugged in.

    Thanks for sharing.

    • Hi Vivianne,

      Thank you. My goal was to create one page reports that are simple, concise, and easy to use. I created the reports as a direct result of financial advisors confusing my estate planning clients and I wanted to find a better way to present the information.

      This way DividendChimp.com Members can see all the information presented in the same format for every stock and easily compare the information and make better decisions on how to invest their money.

      Thanks for reading,
      Devin

  4. I enjoy seeing how people analyze stocks when they are reviewing them for an investment. I don’t believe I saw you list it above but how much do you review non-financial information when making your decision? Companies obviously have wiggle room when it comes to reporting earnings (why else would companies have “one time charges” that seem to appear every quarter), so sometimes relying on the numbers isn’t enough. I will be checking DividendChimp and seeing what kind of information you have to offer!

    • The majority of information contained in my reports is financial data and I feel that where the company is headed is just as important as it’s track record. I take earnings estimates seriously, not just for their insight into growth, but because of how the market reacts to earnings reports and the human factor that effects trading prices. Earnings reports can provide great opportunities to invest.

      To answer your question: I do spend a lot on time on non-financial information also. While most of my reports are financial data, I have a grading system for the intangible data that can’t be expressed as numbers. The grading system reflects intangible assets such as intellectual capital, customer loyalty, competitive strength, innovation, and quality.

      One time charges depend on what they are for, was it to cover a lawsuit or was the money spent on research.

      Research and development must be considered when looking at company’s reports because United States accounting rules dictate that R & D expenses must be charged in the period in which they were incurred, which reduces profits on that quarter, but create an intangible possibility of future profits. It’s important to follow where the company is headed with R & D because if the company is not evolving it’s falling behind it’s competitors.

      Thanks for reading,
      Devin

      • Devin,
        Looking at non-financials and the qualitative aspects can be key and looks like you have a great system in place. I have tried coming up with a grading system myself – for my personal use but didnt really pan out as well as I wanted. Its a work-in-progress I suppose. Thanks for sharing what sort of things you look for.

        Best
        R2R

        • Intangible, non-financial factors can be difficult to assess and it will always be subjective, even if you place a scaling system where you score “x” number out of a possible “y” number, it’s still a subjective assessment, but whatever system you use, its far better than not accounting for non-financials. I think R & D is very important, every company needs to be innovating and evolving. Keep working on your system and as you work with it you will find what factors are really important to you and your system will evolve.

          Best,
          Devin

  5. Thanks for the behind the scenes look Chimp. Glad to have you in the dividend investing community. I am a big fan of your analyses and they are very informative. Keep up the great work and looking forward to following your journey!

    Bert

    • Hi Bert,

      I’m happy to be here, it’s been a pleasure to be able to converse with fellow investors. I’ve been doing this a long time, but I’m new to the blogging community.

      Thank you, I’m happy to hear you like my analyses.

      Best,
      Devin

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