The expected dividend growth can be defined as the rate at which the common share dividends will grow over a period of time.
In order to determine the expected dividend growth for a given stock, one needs to look at the financial statements of the corporation. The three financial statements are income statement, cash flow statement, and balance sheet. It can surely be argued that cash flow is the only statement that is possibly real while other two statements can be engineered by financial wizards. However, I believe that looking all three together is a prudent approach. In context with dividend growth, my viewpoint about these three statements is discussed below. continue reading rest of the article….
The objective of my dividend portfolio is to make investments that result in continuously increasing cash flow. My expectation is that the capital allocated to this portfolio will not be required for a long period of time (i.e. 12 years or more). This objective and methodology allows me to make investments in individual stocks and take higher risk relative to the market. Prior to year 2008, my stock selection process was primarily driven by trend analysis and quality of dividends. Determining fair value and risk factors were very much subjective and based on qualitative viewpoint. I now use little bit more quantitative process. The parameters I use in my evaluation are as follows:
Trend Analysis
The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends for past 10 years.
Revenue
EPS from continuing operation
Dividend per share
Cash flow from operations
Income from operations
Quality of Dividends
This section measure the dividend growth rate, duration of growth, consistency over a period of past ten years.
Dividend growth rate: This should be consistent with growth in earnings per share.
Duration of dividend growth: Dividends should have grown continuously for past 10 years.
4 year rolling dividend growth rate for past ten years: It is preferred to be greater than 10%.
Payout factor: It should be less than 50%.
Dividend cash flow vs. income from MMA: Dividends should be more than income for 10 years of time period.
Fair Value Calculation
This sections determine the what price should I pay to buy a given stock
Net present value (NPV) price based on 20 year Discounted Cash Flow (DCF)
Average high yield price calculated based on past 10 years
Pricing based on past 10 year relative price-to-earnings ratio
Pricing based on price-to-earnings ratio of 12
Graham number
Risk Parameter Calculation (and what-if pricing)
I have recently added this in my stock evaluation process. Here, I use the corporations financial health to assign the risk factor or based on risk factor what should be pricing. This is calculated as:
I am in process of calculating this risk parameter for all of my existing holdings. I will discuss this in more details in next week’s posts.
Qualitative Analysis
I make qualitative judgment of a given stock based on management’s action, roadmap, business environment, position in market, etc. This is a subjective observation.
Acknowledgment: The “4 year rolling dividend growth rate” and “dividend cash flow vs. MMA income” was inspired by methodology used by Dividends4life. These two parameters significantly enhance the quality of dividends from a given stock. My thanks to Dividends4life.
Every investor knows that asset allocation is one of the basic fundamental tenets of portfolio management. Financial publications, peer-reviewed literature, and books have observed that asset allocation is the significant contributor to the total return. This contribution factorvaries anywhere from 50% to 95% depending upon how the data is analyzed with reference to timescale, markets and asset coverage, dividends, inflation, and what not parameters. continue reading rest of the article….
I have identified my goal and formulated a plan for my dividend portfolio. When I am executing this plan, I need to know exactly how I am doing relative to the overall market. It also helps me evaluate how my strategy is performing. I use few different parameters to measure my portfolio performance.
Benchmark:
I use S&P500 based exchange traded fund, SPY, as a benchmark for my dividend portfolio. I consider the first trading day of the year as starting point, and last trading day of the year as end point. The percentage differential of SPY acts as my benchmark. I compare this value to the value of my portfolio. The performance of SPY ETF is marginally less than actual S&P500 index due to the expense ratio associated with ETF. The expense ratio of 0.10% is very small and I do not believe it will have any significant impact on my comparison. The goal would be to ensure (note: not target) that it is always better than this index ETF performance. Now I do not make any proactive efforts to make this happen. I make investments in good fundamentally strong dividend-based companies and hope that market takes care of the rest.
Cash flow:
This is the sum of all dividends received from all stocks in my dividend portfolio. I am still in the portfolio building and accumulation phase of my life. Therefore, all of the dividends are reinvested back into the same stock. My primary objective for dividend portfolio is to increase this cash flow and maintain sustainability. I target to continuously increase my cash flow by consistently making regular investments. My Year 2009 cash flow goals can be viewed here.
Yield-on-Cost (original investment):
YOC based on original investments is metric that determines the yield I am getting from my input capital. The basis for my yield is sum of all input capital (which could be single or multiple batches). Here, I do not add the dividends that are reinvested. This parameter gives me how much my original investments are compounding.
Yield-on-Cost (including dividend reinvestment):
As the parameters suggest, in this YOC, I include all the reinvested dividends. For this YOC, the cost basis is the sum of all original investments and dividends received. In this way, the YOC gives me a measure of dividend growth. This shows the effect of initial yield and the compound growth of that yield.
Annualized XIRR:
Typically, when we want to calculate our individual portfolio returns, the general practice is to use the percentage value based on differentials of present value of portfolio and original investments. This approach is good for calculating the absolute portfolio values at a given point in time. This method does not provide a time-weighted return for our investments. I make multiple numbers of small investments over period of time. Since I give different timeframes for each individual investment, I need to determine the time-weighted returns. This is also known as personal rate-of-return. It can be easily calculated by Microsoft Excel function XIRR. The way I calculate my XIRR is based on my input investments (-ve values) and output value at a given point in time (+ve values). Although the dividends are output from my portfolio, I do not use them because all of the dividends are reinvested back into the stocks. The final output value includes all these new stocks (or dividends).
Portfolio value:
This is the value of my portfolio at a given point in time. Here also, I do not have any control over my portfolio value. Controlling and/or targeting the value of my portfolio are outside the circle of my influence. However, what I can control is how and which particular investments I make. If my portfolio value is significantly different then market and is not sustainable, then it tells me something is not right with my portfolio management process.
I make investments on continual basis depending upon availability of funds and my watch list. However, I do a formal performance review on calendar year quarterly basis. In future posts, I will discuss (1) above performance parameters using an example; and (2) how I use asset allocation as a portfolio risk management.
Let me know your thoughts, comments, and viewpoint on my performance matrices.
Profiling our own investment risk is a very subjective issue. Risk profiling is very much individualistic (i.e. one individual or one family) and I believe everybody would have a unique risk definition. Now it is likely that qualitatively the risk profile could be classified in similar groups. However, quantitatively it would different for each individual.
I view my risk profile as a three-dimensional measure. These three dimensions of risk are (1) Time; (2) Capacity; and (3) Tolerance.
Time is associated with my financial goals and what I want achieve in short-term, intermediate-term, and long-term.
Capacity is how much I can afford and how much I can stretch in my investments. This is an actual dollar amount. e.g. Do I have one million dollar for investments or do I have only $10K to invest or $1000 at regular intervals.
Tolerance is how much volatility in my investments I can afford. This could be percentage based or actual dollar amount.
I have mapped my risk profile on these three dimensions. I have defined three different time scales based on my (i.e. my family) current-state-of-finance.
In short-term (i.e. next 2-3 years), I expect expenses for buying our first house and perhaps buying one additional car. In this case, I have planned dollar amount (i.e. capacity) for which I have zero tolerance. Therefore, all of my investments are in fixed income vehicles. Here there is nothing to manage. Practically, I spend zero time managing this part.
In intermediate-term, i.e. next 6-8 years, based on expected expenses and family’s projected state-of-finance, I am willing to allocate a certain dollar amount that can tolerate some level of fluctuations. e.g. a $10K invested may go down by 25 to 30%. I have a problem if it goes down by 50%, because given the timeframe, this investment can become a negative preposition. My opportunity-based portfolio (and index-based portfolio to certain extent) is targeted towards this intermediate-term. The key characteristic here is smaller number of positions for ease of manageability. One of the very significant aspects on this is rebalancing. I cannot overemphasize this, because rebalancing helps nibbling winners.
In long-term, i.e. 10 years and beyond, I am willing to allocate capital that can take higher fluctuations. Longer timeline builds-in wider tolerance, because I do not have any immediate need to access this capital. My dividend-focused portfolio is a long-term strategy. This blog spot focuses on this aspect of my risk profile.
With this definition of my risk profile, I frame my investment strategy and different investment buckets. It allows me to allocate capital accordingly.
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Asset Allocation is Not Enough for Portfolio Risk Management
Every investor knows that asset allocation is one of the basic fundamental tenets of portfolio management. Financial publications, peer-reviewed literature, and books have observed that asset allocation is the significant contributor to the total return. This contribution factor varies anywhere from 50% to 95% depending upon how the data is analyzed with reference to timescale, markets and asset coverage, dividends, inflation, and what not parameters. continue reading rest of the article….