Tuesday, November 8, 2011

Rating A Dividend Growth Stock

Miss me?  Sorry, I've been caught up in World Series baseball here in St. Louis and then had some computer "nerd" training all last week.  Well I'm back now, so lets get back to talking dividend stocks.

Since I first reviewed Intel a few weeks back I've been working on a way to analyze a stock and quantify it in order to rate if its an attractive buy.  I've come up with something that is a strong foundation, but this may be tweaked in the future.

When analyzing a dividend stock there are three aspects we are concerned with: dividend reliability, dividend growth, and fair value.

Dividend Reliability A stock's dividend reliability is determined by its dividend payment history as well as its current financial health.  Total of 4 points available.
  1. # of Consecutive Dividend Payments - The longer a company has been paying a dividend, the more ingrained the dividend payment is part of the company culture and the less likely it would be removed. 10 to 25 Years = 1 Point
    More than 25 Years = 2 Points
  2. Cash Flow Payout Ratio - Cash flow payout ratio is like dividend payout ratio accept this is the percentage of cash flow that is paid out as dividends.  The lower the better.Less than 60% = 1 Point
  3. Debt to Total Capital - Too much debt can hinder dividend growth as cash is going to debt and interest payments.  Debt includes both long-term and short-term debt and can easily be found on the liabilities side of the balance sheet. Total capital is a combination of debt and shareholders equity. When you divide debt by total capital we want a rate less than 45%.Less than 45 % = 1 Point
Dividend Growth A stock needs to be growing its dividend on an annual basis. The growth of its dividend should be at a respectable rate, especially if the current yield is low. Total of 4 points available.
  1. # of Consecutive Dividend Increases - The longer a company has been consistently raising a dividend, the more ingrained the dividend increase is part of the company culture and the less likely it would be changed.
    10 to 25 Years = 1 Point
    More than 25 Years = 2 Points
  2. 1 Year Cash Flow Payout Ratio <= Avg 5 Year - A cash flow payout ratio that is going up tells us that dividend payments are eating into the company's bottom line.  This could signify a slowdown in dividend growth in the future or a slowdown in the companies earnings.  Ideally we'd like the ratio to be less than or equal to the average 5 year payout ratio.1 year cash flow ratio <= avg 5 year = 1 Point
  3. 1 Year Dividend Growth Rate > Avg 5 Year - If the 1 year dividend growth rate is higher than the average 5 year, then we know the dividend growth is accelerating.  1 year dividend growth rate > avg 5 year = 1 Point
Fair Value - If we're going to buy a stock, we don't want to purchase it went its overvalued.  Total of 2 points available
  1. Current P/E < Avg 5 Year P/E - If the current P/E (price divided by earnings) is less than its average 5 year P/E, then we are getting the stock cheaper today than in the past.Current P/E < avg 5 Year P/E = 1 Point
  2. PEG < 1.5 - The PEG ratio (Price/Earnings To Growth ratio) is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth.  The lower the ratio the better.PEG < 1.5 = 1 Point
With 10 points available, we can break down the total to get a rating on our stock
  • 9-10 Points: Very Strong Stock
  • 7-8   Points: Strong Stock
  • 5-6   Points: Hold, revisit in within a year
  • < 5   Points: Weak Stock, revisit after a year
So did I overwhelm you?  Hopefully not too much.  It can be a lot to soak in, but I think after seeing a few stocks get analyzed it will click.  And I do plan on doing "Boring Terms We Need to Know" soon on the more complicated terms above.

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