In this blog I call dividend stocks that meet my selection
criteria “DIVIDEND MACHINES.” Beginning
in 2011 I selected stocks each year to create an income portfolio of dividend
stocks. Here are the criteria I use to
select a Dividend Machine.
Guidelines for picking Dividend Machines
- EPS, earnings per share greater than dividend paid out
- Dividend Yield greater than 2 year U.S. Treasury
- Consistent Dividend Increases
- Positive Revenue Trend
- D/E, debt to equity ratio, less than 1 or within industry standard.
Earnings Per Share
Earnings per share referred to as EPS, is an easy to find
value. For a stock to be considered a Dividend
Machine, it must create more EPS than dividend paid out. This seems simple however sophisticated
stock analysts will tell you EPS can be manipulated, and free cash flow is a
better measure.
If you can find free
cash flow data on a stock and it surpasses dividends paid out that is a fine
measure to you. If you consider publicly
traded REITS (real estate investment trusts) free cash flow is a better measure
than EPS because REITS by law must pay out 90% or more of their earnings per
share.
You have to decide how much more EPS should be than
dividends paid out. Some argue they want
to own a stock that shares the maximum possible to distribute to its shareholders. Others argue you want a stock to pay out only
50% of their EPS so provide a moat during troubled times. Both arguments have merit and only you can
determine how much EPS should exceed dividends.
Dividend Yield
Every Dividend Machine must pay a significant dividend. To be a Dividend Machine, the stock should
yield more than the 2 year U.S. Treasury.
Otherwise you may as well ladder U.S. treasuries to create your income
portfolio.
Stock dividends have more risk than U.S. Treasuries and therefore,
should pay more yield. How much yield
you need is a complex decision. Going
for very high yields can be a risky proposition. Each year this hurdle varies. In 2018 my Dividend Machines sport a yield of
3%.
Dividend Increases
Growth of your income is the second most important part of
investing for income. Just go back 20
years ago and look at your basic expenses, real estate taxes, car or health
insurance, food and you will find your expenses have doubled. Expect them to double again in the next 20
years. Therefore, your income must double
as will and therefore you need your dividends to increase at least at the pace
of inflation.
In 2018, I look for 3-4%
annual dividend growth at a minimum.
Positive Revenue Trend
Revenues start the funnel of cash needed to pay
dividends. A Dividend Machine stock
should have growing revenues. On occasion,
I have added to a stock that was a Dividend Machine but some fundamental
changes reduced the revenue. A good
example is Chevron, symbol, CVX, is a good example. During periods when oil prices go down, CVX’s
revenues may go down.
This metric has also moved around over the years. Sometimes I look at recent improvements in
revenue to sway my decision whereas other stocks may need to show a longer
stretch of revenue increases. If we want
3-4% dividend growth, then we should seek 3-4 % annual revenue growth.
Debt to Equity Ratio
A pristine balance sheet for any stock you own helps one
sleep at night. D/E ratio (debt to
equity ratio) is an easy value to find on any stock you are considering. Rule of thumb is the lower the debt the safer
the investment. However, some
industries require a lot of capital and carry much higher debt levels.
A good value is to find a stock with a D/E ration at 1 or
less or for those stocks that require a lot of capital, D/E should be within
industry standard.
Discipline Wins
A disciplined approach to income investing helps you make
decisions when the market is giving you mixed signals. Notice in 2011, I pick one stock every week
for 52 weeks. Most of those picks have
done quite well. I paid no attention to
the overall market and it worked out fine.
Good Income Investing,
