We use a basic dividend stock screener to help identify undervalued dividend growth stocks. We have found it very helpful to have a consistent set of metrics to apply to all stocks. Once a stock passes the screener stage, we begin to roll up the sleeves and perform detailed stock analysis. Our three metrics are as follows:
Metric #1 P/E Ratio Less than the S&P 500
Price to Earnings is well documented as a quick metric to identify stocks that may potentially be undervalued. We use this to identify stocks that may be discounted compared to the overall stock market. The S&P P/E ratio is currently above 20X on any given day. So we set our screener at a PE of <15 to identify stocks that offer a pretty decent discount from the market. This is not the only way we use PE though. You also need industry comparisons to unlock further value of the metric. Once a stock is identified, we compare the stock’s PE to their competitors to provide an apples to apples comparison. The <15 metric just helps me identify the companies.
Metric #2 Payout Ratio of Less than 60%
Can a business sustain a business model that uses all (or the majority) of their earnings to pay shareholders a dividend? We do not believe so. There is a healthy balance of rewarding shareholders and reinvesting profits in the company. Through research, reading article, reading books, etc., we believe a Payout Ratio of <60% is a healthy ratio that will allow a company to sustain its current dividend.
We love finding companies that have payout ratios well below our 60% benchmark (<30%). This shows the company has a lot of room to grow their dividend in future periods. Couple a very low payout ratio with a large Cash per Share total and we begin to salivate at the prospects of a future large dividend increase. Conversely, if a dividend ratio spikes above 60%, the stock’s current dividend may be in some serious trouble for the reasons mention at the beginning of the paragraph. Here is a REAL LIFE example of how this worked. In 2014, Lanny successfully identified the decrease in FirstEnergy‘s dividend earlier in the year using this metric. Their payout ratio at the time of the decrease was above 100%. Within weeks, the company announced a drastic dividend cut that slashed both of our forward dividend incomes’ at the time.
Metric #3 Increasing Dividends
It is important for our portfolios to invest in stocks that continue to grow their dividend. If a company’s dividend is stagnant, the yield has the potential to decrease if the stock suddenly has a period of strong price appreciation. In addition, increasing dividends is a signal of strong financial performance by the company. Why? More dollars become available to shareholders!
Lastly, who doesn’t love an investment that historically raises their return to shareholders? It provides a nice little increase to their annual income. Ideally, we would like to see a company grow their dividend at a rate greater than inflation to avoid losing purchasing power on future dollars. However, the growth rate greater than inflation is not the end all be all for us as we own several stocks in our portfolios (T) that do not follow this.
Examples of Applying the dividend Stock Screener:
The following are links to articles in which we have applied the stock screener to various companies. For a few, the application of the screener has helped sway us to initiate a position in the company. We have also written several stock analyses on the website Seeking Alpha. So if you are looking for other examples for our Dividend Stock Screener in action, please check out some of the articles we have written on their website.
DISCLAIMER: WE DO NOT RECOMMEND ANY DECISION TO THE READER or ANY USER, PLEASE CONSULT YOUR OWN RESEARCH. THANK YOU FOR YOUR UNDERSTANDING.