Once a month, I take a tremendous amount of time to create a watch list of undervalued dividend growth stocks. I am using a specific methodology to find undervalued dividend growth stock (defined below) – is it the end all? Obviously not, 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 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 July 6, 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 42 stocks
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 24:
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% (Last month was 2.5%) which eliminated just 4 companies. I wanted a broader base than last month.
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. Again, I was shocked to only eliminate 3 stocks
Dividend Growth Stock Watch List June 2016
The above screen (which I did by hand) leaves me with the following stocks to watch:
- Community Trust Banc. CTBI
- Computer Services Inc. CSVI
- Dover Corp. DOV
- Eagle Financial Services EFSI
- First Financial Corp. THFF
- Franklin Resources BEN
- General Dynamics GD
- Stanley Black & Decker SWK
- T. Rowe Price Group TROW
- Target Corp. TGT
- Wal-Mart Stores Inc. WMT
- Cardinal Health Inc. CAH
- Northeast Indiana Bancorp NIDB
- Enterprise Bancorp Inc. EBTC
- Chesapeake Financial Shares CPKF
- Meredith Corp. MDP
Anyone have any particular feelings about the companies? or my process?