Pre-Screening Dividend Stocks - Part I

Posted by D4L | Tuesday, January 22, 2008 | | 2 comments »

When done correctly, a thorough quantitative and qualitative evaluation takes a significant amount of time to complete. Most stocks are not worthy of that level of evaluation. So how do you know when a stock deserves further evaluation?

As part of my process, I employ a pre-screening model to determine if the stock merits additional evaluation. The pre-screen is designed to determine if any of the following purchase obstacles are present:

  • NPV MMA Differential less than Zero: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? I will never buy a stock as a dividend investment, if I can earn higher income, over time, in a money market account.

  • Dividend Decrease Within the Last 10 Years: When a dividend investor buys a stock the anticipation is the dividend rate will increase over time. The quickest way a stock can exit my portfolio is to decrease its dividend.

  • Held Dividend Constant Within the Last 5 Years: If I own a company that is going through hard times and they have to hold the dividend flat for a year, I will decide whether or not to sell the company based on its future prospects. However, I will not buy a company that has held it dividend constant within the last 5 years.
Tomorrow in Part II, I will post a link to the Pre-Screening Excel Spreadsheet and discuss how to use it.

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2 comments

  1. Michael L. Shuman, M.D. // April 19, 2009 at 1:10 AM

    When I evaluate a prospective stock for long-term dividend income, I look at these factors:
    1. Strong Balance Sheet
    2. Low payout ratio, hopefully <60%, so earnings can cover the dividend.
    3. Strong Cash Flow
    4. No Debt
    5. Long history of steadily paying dividends, with no cuts, and no stagnation.
    6. Long history of healthy dividend increases.

    My question is:

    Some companies have high payout ratios, e.g. >200%, yet still seem to be able to continue their dividend payments. I assume that they are just burning through the cash on their balance sheets until better earnings develop. Would you consider purchasing any stocks with such high payout ratios?

  2. Dividends4Life // April 19, 2009 at 7:55 AM

    Michael: 200% is very high. sometimes a high payout ratio can be a plus if it is a one off. It shows that the company is committed to maintaining its dividend even in a down year. However, payout ratios over 100% can't be maintained forever.

    Best Wishes,
    D4L

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