Once a month, I take a tremendous amount of time to create a watch list of undervalued dividend growth stocks. I am thinking I may be able to outsource this tedious task at some point. I am using a specific methodology to find undervalued dividend growth stock – is it the end all be all? Obviously not, I am not, nor I pretend to be a CFA, but it provides a safe list of stocks to purchase for years or decades to come.
First and foremost, I eliminate 99% of the publicly traded market and focus on those stocks have increased their dividend payments for 20+ years. I use the Dividend Champion List and a part of the Dividend Contender list. This month I am starting with 159 equities (same as last month), and it is at this point, I start screening for individual metrics.
Applying my Valuation Metrics to Dividend Growth Stocks
All my data comes from a snap shot in time (I did the research on August 4, 2016) and all metrics come from Morningstar.com. Warning: This, along with every other screen, is a snapshot in time, and as such, you can’t really rely on it. Rather, the screen should be used just as a starting point for your own research.
Price to Earnings Elimination
First, I eliminate all those stocks with Price to Earnings ratio of 20+ or higher than the individual company’s industrial average. “Price to Earnings” is defined as,
The Price/Earnings Ratio or P/E Ratio is a stock’s current price divided by the company’s trailing 12-month earnings per share from continuous operations.
A fund’s price/earnings ratio can act as a gauge of the fund’s investment strategy in the current market climate, and whether it has a value or growth orientation
This particular month applying this screen I went from 159 equities to 38! Last month I had 38 also. It would be interesting to see if they were the same 38.
Operating Margin Elimination
My next screen is eliminating those companies whose Operating Margin is less than their Industry’s average. Operating Margin is defined as,
a margin ratio used to measure a company’s pricing strategy and operating efficiency.
Operating margin is a measurement of what proportion of a company’s revenue is left over after paying for variable costs of production such as wages, raw materials, etc.
Operating margin gives analysts an idea of how much a company makes interest and taxes on each dollar of sales. Generally speaking, the higher a company’s operating margin is, the better off the company is. If a company’s margin is increasing, it is earning more per dollar of sales.
This particular month I went from 38 remaining equities to 30 remaining companies to look at.
Price to Book Elimination
Third on the list is eliminating those stocks with a Price to Book ratio of above 4 (or if above 4 in line with the industry average). Price to Book is defined as,
A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company
This took us down to 25:
I am not chasing yield, but at the same time, I want to be paid for owning the company – this month I chose 2.0% (same as last month; two months ago it was 2.5%) which eliminated 6 companies (and truth be told 3 more companies were teetering at around 1.95%)
Last, but certainly not least, we have the payout ratio. I do not want to buy into a company whose dividend could be in jeopardy because they are paying too much of their free cash flow to the owners. I was happily surprised that this only eliminated 3 stocks
Dividend Growth Stock Watch List August 2016
The above screen (which I did by hand) leaves me with the following stocks to watch:
- Community Trust Banc. CTBI
- Dover Corp. DOV
- Eagle Financial Services EFSI
- First Financial Corp. THFF
- Franklin Resources BEN
- General Dynamics GD
- SJW Corp. SJW
- T. Rowe Price Group TROW
- Target Corp. TGT
- Wal-Mart Stores Inc. WMT
- Chesapeake Financial Shares CPKF
- Chubb Limited CB
- Meredith Corp. MDP
- Enterprise Bancorp Inc. EBTC
- Northeast Indiana Bancorp NIDB
I then take a birds eye view of 52 week high and lows. I am looking for a big percentage difference from the high and a small percentage difference from the low. That means I am building in a bit more protection as we are close to their lowest point in a year and far from where the stock was already at within the year. If the numbers are both in the single digits that means the stock just doesn’t move all that much.