The Quality Dividend Experiment
I like to fancy myself a dividend investor. I don't claim to be a good one. But dividends are an integral part of my investing strategy, therefore much of my research focus centers around them (I never noticed that the 'C' and 'V' keys were side by side until I nearly admitted to having an 'incesting' strategy. Yikes!).
I've found there to be many worthwhile resouces on this site when it comes to dividends and income investing, whether those resources take the form of fellow bloggers (I would surely forget someone if I listed them individually) or general articles. Of many things that have struck me as I've pored through the advice, insight, and musings provided by these resources, one has been how often stocks with decent, but not necessarily extraordinary, yields are held up as examples of great income investments. For example, Coca Cola (3.3%) and Proctor and Gamble (PG) are often cited.
Now, don't get me wrong. These are good yields and an investor could do far worse than to invest in these stalwarts that offer consistent payouts, demonstrated growth, and safe payout ratios. But the real question, the one I've created this secondary account to answer (What? You actually thought two separate people would want to name their account neskolf?) is whether or not a dividend investor could do better, both in terms of yield return and performance against the market. As such, using the Vanguard stock screener and a set of input parameters that I'll describe in brief (or not so brief), I sought to create a basket of stocks with above average yields that would be a market beating portfolio over time.
Here were the qualifications:
Minimum Yield >4% as of the closing price on Monday, May 10, 2010. At first, I thought that 4% might be setting the bar too low. But as I thought more about it, it occurred to me that a set of logical, stringent screening criteria, while not eliminating it all together, should mitigate risk to the point where the basket of stocks created would have a risk factor not too much greater than government bonds. Thus, anticipated return should only have to be marginally better at worst. A faulty concept? After reading my other criteria, you tell me because I'm open to being persuaded that I've gone astray.
Price/Earnings (ttm), Price/Sales (ttm), and Debt/Total Equity (mrq) < Industry Average I'm not beholden to any single ratio being an end-all, be-all measurement for the return potential of a stock. However, I do think the PE ratio is a nice starting point as to whether or not a stock is reasonably priced as compared to its peers. And I believe that being below industry average in mutiple ratios covers a broader range of what investors might consider pertinient benchmarks.
Payout Ratio<100% Even a mediocre dividend investor such as myself will tell you that sustainability is crucial to a quality dividend. For novice investors, the payout ratio is dividend/earnings. If the dividend exceeds earnings (creating a ratio in excess of 100%), then the company is funding the payment through sources other than earnings such as debt or cash burn, neither of which can be sustained indefinitely. Some people get queasy with a payout ratio greater than 50% (and there's nothing wrong with being that conservative), but I don't. Certain industries will possess relatively high payout ratios (utilities, for example), and therefore I see no reason to disqualify an electric utility with an attractive yield solely on the basis of having a payout ratio of 60%.
Minimum of three years with no missed payments and no cut in dividend Ideally, I would have liked to take this qualification back to five, or maybe even ten, years. But to be brutally honest (I always loved that term. There's something jarring about honesty being brutal), Vanguard's dividend info only goes back three years, and I wasn't about to be arsed with searching out a decade's worth of quarterly dividend payments for 80+ stocks that made it through the initial screen. Given the economic quakes we've witnessed in the last three years, I think having made it through with an intact or growing dividend during that time span speaks to the ability of these companies to keep paying through thick and thin.
Industry Specific In spite of my inital screen returning over 80 stocks, I culled out a number based on their industry (i.e. miscellaneous financial services). Like Buffet (or at least like the Oracle professes), I have to be able to understand how a company makes its money. Barnes and Noble? They sell books, supposedly at a profit. Even I can wrap my brain around that one. AT&T? Something about phones or some such. I use a phone every day. MLPs? No idea how they work. They're out. Banks? Well, I know how banks supposedly work. But I barely trust a bank with the meager funds I keep in my checking account, so they can take a walk.
So, when all was said and done, I was left with 32 stocks that met all criteria (including the last arbitrary one). Seven on the list were unratable on CAPS due to size. That left the twenty five that I have currently green-thumbed. Now for the disclaimers:
I have done no DD on any of these stocks beyond the screening detailed above. I repeat, no DD (unless you consider wanting to punch Luke Wilson in the face for appearing in lame AT&T ads a form of DD). I own no positions in any of the CAPS picks. I am long on two of the stocks that were not ratable. This is an experiment and nothing more. My intention is to eventually create and publish worthwhile research on the issues listed in future blog posts roughly following a schedule of whenever the hell I feel like it.
If you've bothered to read this far, you might as well go ahead and tell me what you think. I'm always looking to find ways to better my investment strategies and endeavors. And if you have bothered to read this far, thank you. Best of luck to all.