Rating A Dividend Income Stock

As I stated in my previous post, I've been focused on analyzing dividend growth stocks as that is what I am allocating at my current age.  But many older dividend investors (probably the majority) are looking for stocks that can provide them with income today.  As I'd hate to alienate a large portion of my potential audience, I decided to come up with an analysis format for dividend income stocks.  This template is similar to my dividend growth analysis, but it focuses more on the safety of the dividend and less on the growth.  I will limit my analysis on stocks that are currently yielding 4% or more and have an established history of paying a dividend.  As in my dividend growth analysis, there are three aspects we will be looking at.  Dividend Safety & Reliability, Dividend Growth, and Fair Value of the stock.

Dividend Safety & Reliability - A stock's dividend safety and reliability is determined by its dividend payment history, its current financial health, and its volatility in relation to the market as a whole.  A total of 5 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
    Greater than 25 Years = 2 Points
2. 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 75%.
   Less than 75% = 1 Point
3. Free Cash Flow Payout Ratio - The percentage of free cash flow paid out in dividends for the year. The lower the percentage the safer the dividend and greater potential for future increases.  We want a rate less than 80%.
   Less than 80% = 1 Point
4. Beta - Beta is a metric that measures volatility of a stock as it compares to the market as a whole.  We are looking for a non-volatile investment so a beta score less than 1.0 is ideal.
   Less than 1.0 = 1 Point

Dividend Growth - Although growth isn't as important when we are buying for current income, we still want a history of increases as well as demonstrated ability to keep up with inflation.  A total of 3 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. 3 Year Avg Dividend Growth Rate > Inflation - The company needs to be raising its dividend to at least stay ahead of the rate of inflation.  The inflation rate we will use is a flat 3%
   3 Yr avg dividend growth > 3%

Fair Value - If we're going to buy a stock, we don't want to purchase it went its overvalued.  We will evaluate an income stock's valuation by its P/E and Yield.  Total of 2 points available.

1. Current P/E < Avg 5 Year P/E - If the current P/E 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. Current Yield vs Avg 5 Year Yield - A higher yield today vs the past is a sign that the stock is selling at a more favorable valuation.
   Current yield < avg 5 year yield = 1 Point

With 10 points available, we can break down the total to get a rating on our stock

• 9-10 Points: Very Strong Income Stock
• 7-8   Points: Strong Income Stock
• 5-6   Points: Hold, revisit in within a year
• < 5   Points: Weak Income Stock, revisit after a year

I hope to put my first stock through this analysis very soon.  As always, readers are welcome to send me stocks they'd like analyzed via the contact me page.