Analysis Parameters for Dividend Stocks

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:

[Price + Yield + Payout Factor + Gross Margin + Operating Margin + Financial Leverage] / 6

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.

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