I hate to sell a stock. When I buy a stock, my intention is to hold it forever and enjoy its ever-growing dividend income. Unfortunately, it doesn't always work that way. Sometimes a stock changes and no longer fits in my income portfolio. It could be a company that cuts its dividend or in some cases freezes its dividend. Let's take a look at a two-step process designed to help us determine if we should sell a stock after a dividend freeze.I. Does The Stock Still Meet Our Investment Criteria?
Dividend investing is about about building a reliable income stream that increases each year. When an investment stops raising its dividend it is no longer providing the future income growth required by my dividend portfolio. The stock may still be a good value, but my dividend portfolio’s primary objective is ever-increasing dividend income, not capital gains.
Obviously, the company's future prospects would play into a decision to keep or sell. Can the company raise its dividend, albeit late, and still preserve a year-over-year increase? Will the future earnings provide sufficient free cash flow to pay a dividend? What other obligations, such as debt, might absorb future cash flows? Is management committed to the dividend? Would you buy this stock today as an income investment? This step determines if the stock is a candidate for a sale.II. Are There Better Alternatives Available?
Once the stock has been identified as a candidate for a sale, the question then becomes is there something out there that is better? Don't forget in determining the market value of a stock, the market considers any known "bad news" about about a company. So after the bad news is out and the company freezes the dividend, the price may drop and increase the effective yield on the stock. Yield on cost is not relevant when considering a sale.
The current price and current yield are what you will receive and give up when selling a stock. With the cash received is there another stock that would be an "upgrade" from the one you are selling? What does its future prospects look like? Will the new stock replace the dividend income lost from the one sold? What does its debt and cash flow look like? Will it continue to grow its dividend in the future? Is it a more riskier stock?
If in answering these questions you determine the stock should be sold, then you pass step two. At this point, you should sell the stock that froze its dividend and purchase the one you identified in step two.A Real-World Example
I am holding three stocks with frozen dividends. Last week I spent some time analyzing one of them - Home Depot (HD). Its quarterly dividend has been frozen at $0.225/share since November 2006. Let's run it through the two-step process and see what happens.I. Does The Stock Still Meet Our Investment Criteria? - Home Depot (HD)
Based on Step I, HD is a candidate for a sale. Let's take it through step 2.II. Are There Better Alternatives Available? - Home Depot (HD)
On the day I was evaluating HD, its current yield was 3.52%. Good, but not great when compared to companies with a similar yield and growing their dividends. So the question is, "If I sold HD, is there another stock that would be an upgrade?" Over the last several weeks I have looked at three companies the piqued my interest. Let's compare them to HD:
1. Genuine Parts Co. (GPC) - [Recent Analysis]
2. General Dynamics Corp. (GD) - [Recent Analysis]
3. Abbott Laboratories (ABT) - [Recent Analysis]
In answering the above questions, I was confident that either GD or ABT would be an excellent replacement for HD. Going into April, GPC was my favorite, but it was disqualified based on its valuation.
I had pegged GPC as a stock to purchase in April. I opted to defer a month and wait until their earnings release on April 16th. Last week GPC reported 11% lower sales and 28% lower income. So why did their stock jump nearly 10% that day? First, they beat analysts prediction by $0.07/share. Secondly, and more importantly to me, they increased free cash flow by $10.6 million, or 8.6%. Management judiciously managed working capital and watched capital spending - signs of good management. Unfortunately, after its run-up, GPC's stock price was was trading well in excess of my buy price of $31.06. For now, I will leave GPC on my watch list.
Taking into account all the above, I sold HD and purchased ABT.
Full Disclosure: Long ABT
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I. Change In Business Conditions
An abrupt or permanent shift in a company's business model as a result of business conditions could lead to a dividend cut. Over the last 18 months or so, virtually all businesses have experienced an adverse change in business conditions. However, the pertinent question is to what degree?Consider Gannett Co. (GCI) who publishes 90 daily U.S. newspapers, nearly 1,000 non-daily publications in the U.S., and close to 300 U.K. titles. With the mass adoption of the internet, traditional news outlets such as newspapers are experiencing a slow death. GCI cut its dividend earlier this year after several years of declining earnings.
Pfizer's (PFE) recent dividend cut would fall in this category. After years of unsuccessful attempts to get approval of a "blockbuster" drug, the cash rich company sought a merger partner with a good drug pipeline. In anticipation of it proposed combination with Wyeth, PFE cut its dividend.
II. Dividend Yield Above Historic and Industry Norms
A dividend yield that is higher than average and/or higher than others in the industry are indications, not all is well with the company. The market is adjusting to compensate for the higher risk of holding the company. When dividend yields start creeping up, it is time to start evaluating if the company can continue to pay its dividend.Consider Bank of America Corp. (BAC). Between 2000 and 2007 the company's dividend yield hovered in the 3%-4% range. In 2008, the dividend yield ranged from around 5% to the teens prior to its dividend cut. The same situation occurred with General Electric (GE) over the same period. GE's dividend yield from 2000-2007 normally were in the range of 1.5%-3.5%. However, in 2008 they the dividend yield than doubled as investors lost confidence in the company. Eventually, BAC and GE cut their dividends.
III. Diminishing Cash Available to Pay Dividends
Ultimately, the ability of a company to pay its dividend is determined by its cash position - both cash on its balance sheet and its ability to generate cash flow. All the companies above had one thing in common - a deterioration of cash flow available for paying dividends.After GCI's free cash flow peaked in 2004 at $1.3 billion, it slipped over the next four years to $852 million in 2008. Though GE's free cash flow was increasing, the company was taking on significant debt. GE's debt increased from $201 billion in 2000 to $524 billion in 2008 and it could no longer afford its dividend.
A Look Ahead
Unfortunately, there will be more dividend cuts in the coming days. Two companies currently on my radar are Nucor Corp. (NUE) and Caterpillar Inc. (CAT).On March 17th, NUE warned of a first quarter loss as the slumping economy sapped demand for the metal forcing it to cut output. "The economy has fallen off a cliff -- and there is no visibility as to the timing of the recovery," Nucor Chairman, Chief Executive and President Dan DiMicco said in a statement. NUE's free cash flows through 2008 had been strong and it ended 2008 with $920 million net debt (debt less cash) vs. $879 million in 2007. NUE is ok for now, but I look forward to reading their Q1 earnings release.
Last week CAT announced that its global machinery sales fell 27 percent in February, the third straight month of declines as the economic downturn has eroded demand for heavy equipment. In a separate announcement the company said it had notified an additional 2,454 workers in three states that they were losing their jobs as the company continues to try to bring production in line with plummeting demand. CAT's financial position is not as strong as NUE. Its free cash flow in 2008 was less than half of 2007 and it ended 2008 with no cash and $33 billion in debt vs. $27 billion net debt in 2007. This is another quarterly earnings release that I look forward to reading.
The above three items will help you determine which companies are at risk of cutting their dividends. Cash is king, so pay special attention to free cash flows and debt levels.
Full Disclosure: Long CAT and NUE.
(Photo Credit)
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One tactic to help manage the risk of a dividend cut is to limit your allocation in any single investment to a maximum of 5%. However, if the allocation is measured by market value, our portfolio may still be at significant risk of a dividend cut. Consider the following:
Below are four of my holdings showing and their percentage of my income portfolio's market value:
Both NNN and ETO are slightly over the 5.0% limit, but not enough to be concerned about. However, when I calculate each of these securities as a percent of my total dividend income the results are not as benign, as shown below:
Combined, these four securities represent 44% of my dividend income compared to only 19.6% of the market value of my income portfolio. I currently have 43 securities in my income portfolio. If each security in the portfolio were equal weighted, then each security should only represent 2.3% of the whole. How did I get into this position?
I have not purchased any O since June 2007 when it was trading at $26.02. With a 12/19/08 closing price of $24.54, its price has has held up relatively well. My average basis in NNN was $21.42 earlier this year. In November, I purchased some additional shares at $14.24 bringing my average basis down to under $20. NNN closed at $16.57 on 12/19/08.
Three stocks were sold in October that had cut their dividends and this created a significant amount of income that needed to be made up. I strongly suspected that AOD was trading well below its underlying value and purchased a large block of it. At the time it was yielding just under 37%. Ten days later the fund itself confirmed my suspicion in a press release saying they had begun purchasing its own shares. Jill K. Evans, co-manager of the Alpine Total Dynamic Dividend Fund was quoted saying:“We know the Fund’s holdings represent strong value right now and seeing 20% plus discounts on a strategy using dividend paying stocks and no leverage, no options, no bonds, and no preferred stock made it clear to us we had to take advantage of this for our shareholders.”
November brought more two more large dividend cuts. Once again I was scurrying to find an acceptable way to make up the lost income. This time I turned to ETO to make up a large part of the income. November's income lost was larger than October's so I spread the purchases around to other high yielding securities, including NNN.
December came and I knew I could not withstand dividend cuts as experienced in the previous two months. I had no more high risk options that I was willing to take. So far it looks like I will make it through Decemebr without a major bump in the road.
I will point out that the above purchases are not quite as risky as it would first appear. The two highest percentages belong to funds (AOD and ETO) so the risk of a draconian cut is much less than an individual stock since funds are made up of many individual stocks. Nevertheless, their percentages are higher than I am comfortable with and I need to build up a risk reserve for future use, so I will work the two funds' balances down with some sales over the next several months.
In the same way you must align your actions with your goals, you must also align your risks with your goals. To that end, I am now tracking each of the securities' percentage of the total income and I will not make an additional purchase if it exceeds 5% in either market value or income. With some careful planning and execution, we will not only make it through this financial crisis, but we will prevail.
Full Disclosure: Long NNN, O, AOD, ETO
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The recent turbulence in the market has provided income investors first hand experience in managing their income portfolio in a declining market. For some, this may be their first significant and prolonged downturn. Here are some things that will help you succeed and thrive during this bear market:
I. Remember Why You Are An Income Investor
The goals of an income portfolio are different than those of a capital appreciation based portfolio. The good news is an income portfolio consisting of dividend stocks can not only succeed, but excel during a down market.
The goal of dividend investors is to build a steady stream of rising income from solid companies. While everyone else is panicked about their portfolio's decline, income investors see the downturn as an incredible buying opportunity.
II. When The Chips Are Down, Go For The Blue Ones
In what seems to be a perpetually declining market, one of the true bright spots is the ability to strategically pickup some bargains in the bluest of blue chip stocks. Normally, these stocks are difficult to buy due to a built in "safety" premium for times like these. Over-allocate safe stocks and save the risker investments for when they are needed (more later). Here are some traditional dividend stocks that that have a RQ rating of A3 or better with their buy below price:
III. Sometimes You Will Misfire
As hard as we may try to pick all winners, sometimes a good stock will go bad, cut its dividend, and we'll have to sell it. Often it is one of our higher yielding stocks, leaving a large void in our annual dividend income. How do we manage this? Here is what I do:
Over the last 2 months, I have had the opportunity to put the above principles into practice. For the year, I have sold five stocks after they cut their dividend. Fortunately, I was able to replace them without suffering a loss in income. As your income portfolio grows, you will not always be able to replace the lost income, but the above principles will help you minimize the decline.
IV. Don't Let Fear Derail Your Long-Term Plan
Someone once said, 'Your emotions are the best inverse indicator of what you should be doing in the market'. Many people are selling it all and walking away from the market. They'll be back though - when the market is reaching all time highs, only to get out when it begins to fall with no end in sight. This is a long-term recipe for disaster. For those of us who still have time before retirement, the market is presenting us with a golden opportunity; what are we going to do with it?
Full Disclosure: Long CNI, ITW, JNJ, KO, PEP, PG, SYY and UTX
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As part of defining your investing process, don't forget to spend some time understanding risk. Seasoned investors will tell you that you should know your risk profile before starting to invest. There are several tools available on the web to help you gauge your risk profile. Here are a few:
Once you know your investment risk profile, how do you gauge the risk of individual securities in your portfolio or your portfolio as a whole? I tend to weigh the risk on my portfolio as a whole and make adjustments through the selection of more or less risky investments. For my dividend stocks I look at these measures:
1. S&P Qualitative Risk Assessment + S&P S&P Quality Ranking
My broker provides S&P reports on individual securities and most ETF/CEFs. As part of this report S&P includes a Qualitative Risk Assessment and Quality Ranking. They define these as such:
For my tracking purposes, I combine the two into a RQ (risk/quality) rating and assign A (low), B (medium) or C (high) for the Qualitative Risk Assessment and 1 (A+) to 8 (D) for the Quality Ranking. Thus a company such as Coca-Cola (KO) that has a Low Qualitative Risk Assessment and a Quality Ranking of A would be represented as an A2 company in my system. Here are some combined rankings on several popular dividend company's:
capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings from highest to lowest: A+, A, A, B+, B, B-, C, D and Not Ranked.
Currently, I don't have any C stocks. My most risky stocks have a rating of B4. I like use this metric to evaluate my dividend stock portfolio in total. The weighted average of my dividend stock portfolio is A3. I am comfortable with that rating, but under the right circumstances I would be willing allow it to fall to B2. If the overall portfolio fell to a B (moderate risk), I would limit the S&P Quality Ranking to a 2 (A). I would never want the overall S&P Quality Ranking to drop below a 3 (A-). Click here to see the RQ rating for all my dividend stock holdings.
2. Current Dividend Yield and NPV of MMA Differential
All things being equal, higher risk stocks command a higher dividend yield. Consider these two extremes:
If you had to invest your life's savings in only one of the above stocks, which would you choose? Your answer will reveal something about your risk tolerance. Obviously, the market believes that WMT is less risky than CTL.
When judging risk I like to look at current dividend yield in conjunction with NPV of MMA Differential. A high yield and a high NPV of MMA Differential could indicate a risky stock. Here are some risky stocks and ETF/CEFs that I am holding based on a high current yield and NPV of MMA Differential:
Many of the recent companies that I sold after a dividend cut resided at or near the top of this list when they cut their dividend. Of the two methods, I have found the second one to be a better indicator of future performance.
In addition, I also look at the current market price vs. my calculated Buy Below price. A large disparity indicates the market believes the stock will perform much differently in the future than it has in the past. As with any forward looking exercise, it is a mixture of art and science.
Full Disclosure: At the time of this writing, I was long in GE, USB, JNJ UTX, PG, WMT, AOD, ETO, CTL, PAYX
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In January 2008 I released my Dividend Stock Pre-Screen Model. Since then I've modified the model several times to add additional functionality, correct bugs and update annual information such as the default MMA Yield. The updated model is linked on the Tools page as D4L-PreScreen.xls.
The file contains the following tabs:
The Screen tab is divided the following five sections:
I. Input: All cells requiring your input are shaded yellow. They include:
II. Projected Information: This section calculates 20 years of balances for two hypothetical $1,000 investments; one in a MMA earning the yield input above, and another in the stock entered above. Both the dividends and interest are reinvested. The MMA differential is the difference between the two investments. Proj. Yield on Cost is the projected yield on cost based on the stock's dividend growing at Calc. Div. Growth or Override Div. Gro. above and the stock's original cost.
Three scenarios are considered:
- No Price Appreciation This model assumes that the share price remains constant, thus the dividend yield grows each year based on the dividend growth rate. It also assumes all dividends and interest are reinvested.
- Price Appreciation = Dividend Growth
This model assumes that the share price grows at the dividend growth rate, thus the dividend yield remains constant. It also assumes all dividends and interest are reinvested. - Dividends/Interest Not Reinvested
This model is identical to the No Price Appreciation model, except the dividends and interest are not reinvested.
III. Interpretative Analysis: Calculates several relevant pieces of information and allows you to set a minimum threshold on certain items. The items calculated are:
- NPV of MMA Differential: This is the net present value of the MMA Differential calculated in the projected information section above for each of the scenarios and for the cumulative scenario. You can enter the minimum acceptable level for the cumulative scenario in column C.
- Sum of MMA Differential: This is a simple sum of the annual values calculated in the projected information section above for each of the scenarios.
- Metrics 1-5: Are specifically defined within the worksheet. Metrics 2 and 3 allow you to enter the minimum acceptable level in column C.
V. Disclaimer: Too many attorneys with not enough work for my liking....
The Database tab allows you to keep up with what stocks have been pre-screened along with the results of the of the screening and the recommended year for the next screening. I have it divided into three sections:
- Stocks To Consider (green): These are stocks that you currently own or would consider buying in the future.
- Reconsider Later (gray): These are stocks that have previously failed the pre-screen. They are listed here to let you know that they have been screened before and when they are due to be screened again.
- Never Consider (red): If you are opposed to stock and know you will never consider owning it, listing it in this section ensures it will always be rejected.
- The stock symbol (column A): The ticker symbol is used to look up information that is stored on the Database tab, but is displayed on the Screen tab.
- Flag (column B): A "X" in this column will flag the stock as rejected and display the comment on the Screen tab in cell D7.
- Comment: Whatever you want to say about the stock. As noted above, the comment is displayed on the Screen tab in cell D7 when there is an "X" in the Flag field.
The examples in Part III have been updated to match the changes made in the model. These examples will walk you through several different situations and point out things to look for.
(Photo: Steve Woods)
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With all the other investment strategies out there, why should investors consider dividend or income investing? Based on articles that I have previously written, presented here are seven important reasons for dividend investing:
Maybe I am just biased but, I firmly believe that dividend stocks and ETFs should have a spot in everyone's portfolio.
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Even if you work from home, you should have a refinance plan, where the real estate is involved and regular checks on the insurance too.
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Dividend investing is similar to planting a mango tree. Things start very slowly at first. It appears as if all your efforts are in vain, but ever so surely the process begins to produce fruit (dividends). In about 8-10 years most good dividend companies' yield on cost (YOC) reaches a level that equals a money market account, and continues to grow from there.
Just as picking fruit from a mango tree does not harm it, living off dividends does not damage the investment's ability to produce future results. A mango tree's life will easily span an entire generation. Similarly, well-chosen dividend investments will not only provide income in retirement, but can be passed to your children who can continue to reap the benefits.
If you want to enjoy tomorrows dividend fruits, you will need to plant and nurture the tree today.
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It is important to periodically review your asset allocation across all your holdings. In yesterday's post "2008-Q1 Progress Review", I presented the results of a significant project I undertook to measure my asset allocation over all my investment holdings using three different measures (origin, capitalization and sector). As I pointed out yesterday, I was surprised that some of the areas I thought would be over-allocated were not when evaluating the portfolio as a whole (financials and real-estate), while other areas came up short (international).
When I started this project, I had visions of wading through annual reports for mutual funds, ETFs and trying to figure out a way to get the allocation for investments in my 401(k). I started with my 401(k) since I thought it would be the most difficult. I found my 401(k) had outsourced this tedious-task to Morningstar. As it turns out, Morningstar became my one stop source for all my investments (mutual funds, ETFs and individual stocks). By using only one source provider, the data was consistent. Here is an example of SPDR S&P Dividend ETF (SDY).
The style box will tell you if it is large, mid or small cap (also value, blend or growth, if you are tracking that). You will notice the sector breakdown is exactly what I used in my sector presentation. The asset allocation provides a split between cash stocks bonds and other. The weakest link is international vs. domestic, For my 401(k) funds, the percentage is presented in the report. For others, such as HOTFX, you have to look at the category listed under key stats. HOTFX is listed as "World Stock" so I treat it as international.
I spent a great deal of time designing a new tab in one of my two massive spreadsheets. It is now set up so that I can cut-and-paste the above information from Morningstar into my spreadsheet and the data for the PDF presented will automatically be updated. From start to finish, the whole process can be completed in about 20 minutes. This is something I plan on looking at quarterly.
Are you currently reviewing your asset allocation across all your investments?
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When we don't have an immediate need for something we put it on a shelf. This gets it out out sight and out of our way until we need it or otherwise evaluate its usefulness. Sometimes it is the first step to the garbage, while other times the item works its way back into our everyday life. I have expanded my investing process to include a shelf.
If a security is not performing at the desired level for additional purchases, but also is not performing badly enough to warrant a sale, then I will put it "on the shelf". By that I mean it will be set aside within my income portfolio with no additional purchases made until its outlook improves or deteriorates to the point it should be sold. This is a tactic that I will use to help overcome my strong bias for action.
Tomorrow in my "State of the Dividend Address" I will look at several stocks in my portfolio that I am not satisfied with, for one reason or another. Decisions will be made as to their future direction. Some will involve the "shelf".
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In the past, I have described in depth how many of the items in my stock analysis are calculated. In some instances, such as the dividend growth rate, I have provided models that allow the reader to see and duplicate the calculation found in my stock analyses.
I have made passing references that all the quantitative calculations in the attached PDF file are totally mechanical, including the final 1-5 Star ratings. This was well illustrated in the Sometimes Things Aren't As They Appear series, where the quantitative analysis ranked C as a 5-Star Strong Buy, but at the time I was avoiding the stock. In the same series, I reviewed GE and the quantitative analysis ranked it a 0-Star Avoid stock, yet I was adding to my position.
As noted in the post, a Quantitative Analysis is mechanical and inherently driven by historical results, while a Qualitative Analysis is more subjective and is the most difficult part of the overall evaluation process. Simply put, a Qualitative Analysis investigates the why and how of decision making (forward-looking), as compared to what, where, and when of quantitative research.
The bottom line: All stock analyses presented are quantitative, including the Star recommendation, and are backward looking. They assume the stock will perform in the future as it has in the past. This is generally never true. I will sometimes interject some Qualitative thoughts, which are my opinion only, but none of this should be considered a buy or sell recommendation. As always, before buying or selling a security, you should do your own research and reach your own conclusion.
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What is the best way to begin accumulating a new security? There are probably as many approaches as there are investors. I have seen where some people jump in and immediately purchase the entire block needed to complete their asset allocation. While others use a more gentle approach of buying-in at predetermined amount and time. As an example, I have seen where some will buy 1/3 of the desired weightings every four months, so that they are fully invested in one year.
The approach I take is less mechanical. As noted in some past articles (Dynamic Dividend Investing, It Was An Odd Odyssey, Is It Time To Upgrade Your Portfolio?, etc.), I like to initiate a small position in a company (or fund) to get to know it better - kind of like dating before marriage. By having a stake in the company, this forces me to get to know the investment, its management and its behavior in the market. If I like what I see, I usually purchase another small block; otherwise, I end the relationship. Over time, this dating process can lead to full commitment (marriage) where the investment is an integral part of my portfolio.
In most instances, I will wait at least three months between purchases of additional shares. In addition to learning more about the company, waiting three months allows time to see the next dividend declaration. Usually between nine months and a year, I determine if this is a company I want to make a long-term commitment to. Once I make that determination, I aggressively increase its allocation to my desired allocation level.
How do you initiate a position in a stock?
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Asset allocation describes how an investor distributes their investments among various classes of investment options (e.g., stocks and bonds). Most successful investors will tell you that asset allocation is the most important decision you make in determining how well your portfolio performs. As noted in my recent article Charlie Munger's 10 Rules for Investment Success, he pointed out "Allocate assets wisely: Proper allocation of capital is an investor's No. 1 job."
The conceptual foundation of asset allocation is the premise that the best-performing asset(s) will vary from year-to-year and is not easily predictable. By spreading your investments across various asset classes, some will be over-performing while under-performing - Don't put all your eggs in one basket. With fixed percentages on each of the asset classes you reallocate out of the better performing assets into the under-performing assets - Buy Low, Sell High.
Examples of asset allocation classes include, by asset type: Cash, Bonds, Stocks, Real Estate, Currencies, Natural Resources, Precious Metals, Collectibles, etc.
When looking at equities they can be sub-divided into additional asset classes grouped by:
- Size such as: Large-Cap, Mid-Cap and Small-Cap
- Style such as: Growth, Blend and Value
- Sector such as: Financial, Consumer, Industrial, Health-care, etc.
- Other such as: REITS, International, Emerging Markets, Life Settlements
There are a lot of tools available on the web to help you determine your asset allocation. Here are three, one very simple and the other two a little more comprehensive: Once your asset allocation is set, it is not changed often. The most common reason for changing your asset allocation is a change in your time horizon. As you approach your investment goal, such as retirement, you may want to reevaluate your risk profile. It is important to note that savvy investors typically do not change their asset allocation based on the relative performance of asset categories.
As described in my article "Process Overview and Asset Allocation", I currently allocate assets broadly by the type of investment (mutual funds, ETFs, dividend stocks) with some attention given to sectors within my dividend stocks. I am currently working on refining my process and will discuss this in future posts.
If you are interested in learning more about asset allocation, The U.S. Securities and Exchange Commission (SEC) has a good primer on asset allocation titled "Beginners' Guide to Asset Allocation, Diversification, and Rebalancing".
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In Wednesday's article "Pre-Screening Dividend Stocks - Part II", I posted a link to [D4L-PreScreen.xls]. This was a cleaned up version of a tiny section of my two massive financial spreadsheets.
My wife would tell you that I am practical to a fault. I am not into appearance for the sake of appearance. I drive an inexpensive practical car and don't spend a lot of time fretting over how it looks. With that said, I thought some of you would enjoy a glimpse of my pre-screen model embedded in one of my two massive spreadsheets. Here's a peek at it:
Some of the items should look familiar to you. In cell F1 is the "Max Div. Growth" input; "Symbol" is in cell A132; the "NPV of MMA Differential" is calculated in cell D132; "Current Yield" is entered in I132; the outcome/action is in cell A134; the comment is in cell C134; "MMA Yield" is entered in C137. You will also notice my "Stocks to Pre-Screen" section around cell A144. My file is horizontal with each stock contained on a single row.
At the time of this writing there are approximately 100 securities that I am tracking in this file. This tab is linked to another tab where prices and yields are updated daily, which in turn will recalc NPV of MMA Differential for each file. This allows me to monitor securities such as JNJ that are on the borderline.
I must admit to a little spreadsheet envy after I built [D4L-PreScreen.xls]. However, the one above has been serving me well for many years, so I think I will keep her.
TV Trivia Question: What popular mid '60s to mid '70s TV show introduced the word "Epilogue" into the main-stream? Leave a comment with your guess. Don't know? Check back tomorrow for the answer!
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Last Updated: December 27, 2008
This post provides several examples on how to use my D4L-PreScreen.xls model for prescreening dividen stocks. I have tried to select a diverse group to cover multiple outcomes. For your convenience, all the sample data is included on the Database tab. I am assuming you are familiar with Excel and are comfortable with basics such as copying, pasting, entering data, etc.
Example #1 EX1: On the Screen Tab enter "EX1" as the symbol in cell C6. Enter the Current Yield in cell C8 and the last 11 annual dividends in cells J9 to T9 - all this information is available on the Database tab on the EX1 row beginning in column H (H9 to T9). If cell B48 is (1,758), then you have everything entered correctly.
The first thing you will notice is the "Do NOT Buy!" in cell D6. In this case, the "Do NOT Buy!" warning is a result of the NPV of MMA Differential in cell B48 being less than the minimum in cell C48. You can easily see why this is negative by looking at the MMA Differential line starting at C22 and C23. It will be 2023 before an investment in EX1 will produce more income that a MMA, cumulatively it will take until 2029. The way discounting works, the earlier years are more heavily weighted. You should never buy an income investment with a negative NPV of MMA Differential.
Note that cell D7 tells you that EX1 has been previously evaluated and should be reevaluated in 2011. This is confirmed by looking at cell B66.
Example #2 EX2: On the Screen Tab enter "EX2" as the symbol in cell C6. Enter the Current Yield in cell C8 and the last 11 annual dividends in cells J9 to T9 - all this information is available on the Database tab on the EX2 row beginning in column H (H10 to T10). If cell B48 is 41,354, then you have everything entered correctly.
Again, you get the "Do NOT Buy!" in cell D6. This time the "Do NOT Buy!" warning is a result of the Metric 2, consecutive years of dividend increases, in cell B54 being less than the minimum in cell C54. Looking at cells J9 and K9, you can see the dividend was flat in 2009. In spite of its great yield and 10+ years without dropping a dividend, my pre-defined rules say that I will pass on this company.
As with EX1, cell D7 tells you that EX2 has been previously evaluated and should be reevaluated in 2016. This is confirmed by looking at cell B66.
Example #3 EX3: On the Screen Tab enter "EX3" as the symbol in cell C6. Enter the Current Yield in cell C8 and the last 11 annual dividends in cells J9 to T9 - all this information is available on the Database tab on the EX3 row beginning in column H (H11 to T11). If cell B48 is 28,540, then you have everything entered correctly.
Once again we are greeted with the the "Do NOT Buy!" in cell D6. This time the "Do NOT Buy!" warning is a result of the Metrics 2 and 3. In the example we will focus on Metric 3 consecutive years without decreasing a dividend. This stock is considered a "Do NOT Buy!" since cell B55 is less than the minimum in cell C55. Looking at cell O9, you can see the dividend dropped in 2004. In spite of its great yield, my pre-defined rules say that I will pass on this company.
As with the earlier examples, cell D7 tells you that EX3 has been previously evaluated and should be reevaluated in 2016. This is confirmed by looking at cell B66.
Example #4 EX4: On the Screen Tab enter "EX4" as the symbol in cell C6. Enter the Current Yield in cell C8 and the last 11 annual dividends in cells J9 to T9 - all this information is available on the Database tab on the EX4 row beginning in column H (H12 to T12). If cell B48 is 2,437, then you have everything entered correctly.
Like Example #1, EX4 greets you with a "Do NOT Buy!" in cell D6 as a result of the NPV of MMA Differential in cell B48 being less than the minimum in cell C48. This time it is positive and close to our acceptable minimum.
So, what would it take to make EX4 worthy of additional consideration? Two inputs will increase the NPV of MMA Differential, 1.) a higher dividend growth rate or 2.) a higher current yield. I built the functionality in the model to determine each.
To calculate the minimum dividend growth rate to break even, press the button in cell D13. This will plug the override dividend growth rate in cell C13 until cells B48 and C48 equal. In this case it took just 0.5% or an override value of 11.5%.
To calculate the minimum dividend yield to break even, first enter 0 in cell C13, then press the button in cell D8. This will plug the dividend yield in cell C8 until cells B48 and C48 equal. In this case it took just 0.10% or an override value of 2.15%. Cell C9 shows you at what price EX4 must trade to yield the needed 2.15%.
Both of the above values are so close, EX4 could be worth a closer look.
Example #5 EX5: On the Screen Tab enter "EX5" as the symbol in cell C6. Enter the Current Yield in cell C8 and the last 11 annual dividends in cells J9 to T9 - all this information is available on the Database tab on the EX5 row beginning in column H (H7 to T7). If cell B48 is 6,199, then you have everything entered correctly.
Finally, a "Worthy of additional consideration" stock. That means this stock has not yet disqualified itself, so you can now probe deeper to determine if it is a buy. That process will be covered in other posts.
As a side note, you can calculate the minimum dividend growth rate and the minimum dividend yield to break even, as we did in Example 4. In this case, it will be lower since the NPV of MMA Differential is in excess of the minimum.
One additional feature I need to mention is the "Stocks to Pre-Screen" section around cell B50. Whenever someone mentions a stock that I would like to evaluate as a potential dividend investment, I will enter the symbol in this section. If it is not in the database #N/A will appear, if it is flagged as a reject "---DELETE >>>" will appear and if the stock is on the to consider list then "ok" will appear. When I evaluate the Aristocrats and the Achievers, I copy them to this section and eliminate the deletes.
As always, I hope you find this model entertaining and useful. Please let me know if you come across any bugs. It took a lot of hacking to extract it from my two master financial spreadsheets.
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This post has been updated. Click here for the newer version.
As I have mentioned before, my entire financial existence is contained in two massive spreadsheets. From these spreadsheets, I have extracted the portion that I use for pre-screening dividend stocks. It is linked on the tools page as D4L-PreScreen.xls. The file contains the following tabs:
- Screen: Is where you enter information about a stock and a recommendation is generated.
- Database: Over time I keep "rediscovering" the same stocks. The database tab allows me to keep up with what stocks I have previously screened, the results of the screen and when the stock is eligible to be screened again.
I. Input: All cells requiring your input are shaded yellow. They include:
- Symbol: Enter the stock's symbol here.
- Year: Enter the last year in which annual dividend data is available.
- Current Yield: Enter the stock's dividend yield.
- Calc. Div. Growth: This field calculates the stock's dividend growth [NOT AN INPUT]
- MMA Yield: Enter what you can earn on a money market account.
- Max Div. Growth: Enter here the cap (maximum) for Calc. Div. Growth.
- Override Div. Gro: Enter here an override rate for Calc. Div. Growth.
- Annual Dividend/Share: Enter here historic annual dividend information.
III. Interpretative Analysis: Calculates several relevant pieces of information and allows you to set a minimum threshold on certain items. The items calculated are:
- NPV of MMA Differential: This is the net present value of the MMA Differential calculated in the projected information section above. You can enter the minimum acceptable level in column C.
- Sum of MMA Differential: This is a simple sum of the annual values calculated in the projected information section above.
- Metrics 1-5: Are specifically defined within the worksheet. Metrics 2 and 3 allow you to enter the minimum acceptable level in column C.
V. Disclaimer: Too many attorneys with not enough work for my liking....
The Database tab allows you to keep up with what stocks have been pre-screened along with the results of the of the screening and the recommended year for the next screening. I have it divided into three sections:
- Stocks To Consider (green): These are stocks that you currently own or would consider buying in the future.
- Reconsider Later (gray): These are stocks that have previously failed the pre-screen. They are listed here to let you know that they have been screened before and when they are due to be screened again.
- Never Consider (red): If you are opposed to stock and know you will never consider owning it, listing it in this section ensures it will always be rejected.
- The stock symbol (column A): The ticker symbol is used to look up information that is stored on the Database tab, but is displayed on the Screen tab.
- Flag (column B): A "X" in this column will flag the stock as rejected and display the comment on the Screen tab in cell D7.
- Comment: Whatever you want to say about the stock. As noted above, the comment is displayed on the Screen tab in cell D7 when there is an "X" in the Flag field.
In Part III tomorrow, I will walk you through several examples and point out things to look for.
Related Articles:
- Pre-Screening Dividend Stocks - Part I
- Pre-Screening Dividend Stocks - Part III
- My Unique Investing Process
- Dividends4Life Toolbox
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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.
Related Articles:
- Fishing in the Bathtub
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- Pre-Screening Dividend Stocks - Part II
- Pre-Screening Dividend Stocks - Part III
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From an investing standpoint, there is nothing I enjoy more than beating the S&P 500. As noted in my Process Overview and Asset Allocation article, approximately one-third of my taxable portfolio is invested in Mutual Funds. I have a small amount invested in Vanguard's S&P 500 Index (VFINX). I use this fund as my benchmark - if I can't beat it over time this is where I need to put my money. The fund I have invested in for several years is The Davis Selected American Shares Fund (SLASX). Between 1993 and 2006 it out performed the S&P 500 in all but 4 years. 2006 was one of those four years and it looks is if SLASX will under-perform in 2007 (4.79%-SLASX vs. 5.39%-VFINX).
Given our long relationship, I am not ready to break up with SLASX just yet, but we have decided to see others. While scouring the horizon for a fund that will help me meet my objective of consistently beating the S&P 500, I came across the FundX Aggressive Upgrader Fund (HOTFX). It has a good track record of beating the S&P 500 through active management. Below is a chart showing the performance of the three funds:
Being a process-oriented person, what intrigued me about this fund was the "upgrading" process it used in managing the investments. From their website:
Our Investment Process
Upgrading is a method of systematically investing in securities that rank highly in our scoring system. We hold them as long as they continue to outperform their peers, then sell them when they fall in our ranks. We then reinvest the proceeds in the new strong performers. DAL Investment Company developed this strategy over the past 35 years.
Unlike market timers, we do not attempt to predict the movements of the market to move back and forth from stocks to cash. Upgrading is also unlike a typical buy-and-hold approach. Instead, Upgrading moves us flexibly among those areas of the market showing the best relative performance. Upgrading allows us to invest in what we believe are the best performing securities available-whatever the current market conditions.
How Upgrading Works
DAL's Upgrading approach involves measuring near-term performance of mutual funds (twelve months and less) and comparing them to returns of other funds with similar risk. We invest in funds with the best recent returns, and monitor their performance. When a fund drops in our ranks, we “Upgrade” to the new market leaders.
Near Term Performance is Key
Unlike most investment approaches, Upgrading only considers near term performance because only near-term returns indicate funds doing well in the current market environment. Funds that have outperformed in recent quarters tend to continue to show strength into ensuing quarters, a phenomenon known as "persistence of performance." Upgrading is a disciplined method of exploiting this phenomenon.
In short HOTFX is employing a momentum strategy. This strategy carries a higher degree of risk than a buy-and-hold strategy. As noted on the FundX website (emphasis added is mine):
The FundX Aggressive Upgrader Fund (HOTFX - Inception 7/1/02) is designed for investors willing to take on above-average risk in the hopes of achieving higher returns over time.
HOTFX may be appropriate for long-term investors who are willing to accept a considerable level of market risk associated with investing in a portfolio that depends exclusively on the value of common stock holdings concentrated in one or more sectors or industries.
HOTFX could be a core holding if you're an aggressive investor, but more likely is more suitable as a speculative component of a diversified portfolio for long-term growth.
Full Disclosure: Last week I initiated a position in HOTFX. I will continue to evaluate HOTFX and add to my postion monthly as long as I believe it will out perform SLASX and VFINX, over the long-term.
I do not have near-term plans to sell any SLASX or VFINX. My position in HOTFX will be built with new funds over time.
Do you peridocially review your portfolio to determine if you can optimize it and increase its overall return?
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Sometimes events in our life require a change from the norm. This week, I need to interrupt my normal posting schedule and move the main article from Wednesday to Thursday to make room for today's post.
We had drifted apart. At first it was barely noticeable, but as time went on I saw how she would gently pull back her arm back when I reached to touch her. We were headed in different directions. Time passed she grew colder toward me. I desperately tried to make things work. Then on November 1, 2007 we agreed to a trial separation for a period of time. It was a difficult time for me. I kept wanting to run back to her, but I restrained myself knowing she had some issues to work out.
Then it happened! The thing I feared most - on Tuesday January 15, 2008, I caught her in an act of infidelity. There she was embracing the one I despised the most. At that point, I knew it was over between us. I immediately severed the relationship. C, I hope you enjoy your life with Mr. Div I. Dendcutt. For me I'll pick up the pieces and move on.
Breaking up is never easy to do. Citigroup's dividend drop on Tuesday has been well publicized. I had anticipated this happening and sold C in my taxable account on November 1, 2007; however, that doesn't make it anymore palatable. As is my standing practice, I immediately sold C (held in my IRA) once I learned the dividend had been cut. That is Rule #1 as to when to sell: When an individual stock held as a dividend investment drops its dividend immediatly sell it.
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