This guest post has been written by Mike McNeil, passionate investor, founder of Dividend Stocks Rock and author of The Dividend Guy Blog.
I started investing when I was 23, back in 2003. Those were the good times and I luckily sold most of my portfolio to buy a house in 2006, 2 years before the market crashed. In a search for a more efficient and less stressful way to invest, I decided to switch my holdings towards a dividend growth investing strategy in 2010. Two years later, 100% of my portfolio was invested in dividend paying stocks. As it is probably the case for most of you, the past 5 years have brought stellar returns.
As many investors start worrying about the stock market trading at a very high PE ratio, I consider reviewing my investing process. Not because I fear a market correction. I don’t fear it, I know it will happen, we just don’t know when it will happen.
But does it matter?
No, it doesn’t.
It doesn’t matter because staying invested in strong dividend paying company is the only way I can achieve my goals. However, investing in dividend stocks doesn’t mean investing in any kind of company making quarterly distribution. Therefore, it is important to tighten your investment process so that aren’t any bad decisions made.
The market is high, is the buying over?
Source: http://www.multpl.com/
From time to time, I like to see how the average PE ratio of the S&P 500 goes. It gives me an indication if the overall market is well or completely disconnected from reality. Now, I can only say it looks terribly disconnected…
However, this is also the kind of rationale that made millions of investors waiting on the sideline since 2012 letting a very strong bull market go right in front of them. Should you jump in the train now? The answer is yes. Because today is always a better timing than tomorrow. Waiting for the famous pull-back won’t serve you much as you will miss months, read years of dividend payment in the meantime. Plus, there hasn’t been a strong pull back since the 2008 crash… this is almost a decade ago now. The solution to your waiting-for-the-right-timing dilemma is easy; build a strong investing process and buy companies that will go through any kind of catastrophe.
Setting a stronger investment process
When I look for a new company to add to my portfolio, I always start by pulling out a general filter. I have a few variations of filters, but it usually goes along the following lines:
● 1.50% < Dividend Yield (TTM) < 5.00%
● 0.01% < Dividend Per Share (5 Year Growth) <
● 0.01% < Dividend Per Share (3 Year Growth) <
● 0.01% < EPS Diluted (5 Year Growth) <
● 0.01% < Revenue (5 Year Growth) <
● 0.01% < Revenue (3 Year Growth) <
● 10.00% < Payout Ratio (TTM) < 100.0%
● 10.00% < Cash Dividend Payout Ratio (TTM) < 150.00%
I use the powerful stock screener provided by Y Charts. Such preliminary search would bring on my table about 250-300 potential companies. From this list, I tend identify companies showing strong numbers in three specific components:
● Revenue growth
● Earnings growth
● Dividend growth
This is a simple combination telling me which companies are currently growing faster than others. Over the past 5 years, the number of companies succeeding in showing both revenue and earnings growth has been shrinking due to global economy slowdown and currency headwinds. Identifying stronger companies is key when you buy in an all-time high market.
To make sure those companies are not surfing on the bull market wave with artificial numbers, I then pick them one by one and explore their dividend growth potential. I use metrics like the payout ratio but also the cash payout ratio. I want to see how much money is coming out of the company’s bank account to pay for the distribution. There is a red light each time I find a company showing a payout ratio close to 85%. This tells me the room for future dividend increase starts to get thinner.
Finally, once I have only a handful of company left from those filtering steps, I write down my investment thesis for each of them. This is a crucial step, in fact, this is the most important one. Identifying the reason to buy shares from a company is also identifying the potential reasons to sell it when the time is due. I review each of my holding on a quarterly basis to make sure my investment thesis still stands. In the event of I was wrong or the company made some missteps, I then sell my shares and find another solid company. Fortunately, this situation doesn’t occur often mainly due to the fact I operate a solid investing process through 7 dividend growth investing rules. A stronger process helps me identifying companies that will go through major recessions. However, this doesn’t mean that I’m willing to overpay during the peak of a bull market.
Using the dividend discount model (DDM)
The valuation method I use to make sure the company still have room to grow in the future is the dividend discount model (DDM). By using a double stage discount model, I can use a first 10-year dividend growth rate and a terminal growth rate for the years after. This generate multiple variation of calculations helping getting my head together as to which is a good entry point for a specific company.
This is the result of my valuation of BlackRock (BLK) done a few months ago, I can see that based on my calculation, BLK should be valued at $420.67. I can also see the variation in the valuation model using a different discount model (vertical columns) and different margin of safety if my assumptions are wrong (horizontal columns).
The advantage of the DDM is that it calculates the value of a stock solely based on its dividend payment potential. Therefore, it doesn’t really matter what is the current PE valuation if the company continues to distribute higher paychecks year after year.
Get the research done for you
I know that completing a rigorous investment process requires lots of time that most of you probably don’t have. When one manages his investment, the biggest problem is not the lack of knowledge, but rather the lack of time. For this reason, I’ve built Dividend Stocks Rock, an investing platform where the research is done for you.
At DSR, we take the time you lack to build and apply rigorously a proven investing process. We can monitor the market and move money accordingly to make sure we sell companies that are not meeting our criterions. Each time we do this, you receive an email immediately.
How does it work?
We have built a whole platform with everything you need to build and manage your dividend growth portfolio:
We have built a whole platform with everything you need to build and manage your dividend growth portfolio:
● A monthly newsletter offering top picks for each industry;
● Taylor made portfolio models providing buy & sell alerts;
● 70+ stock cards to save you time doing research.
DSR has been built with the investor in mind. Therefore, it is way cheaper than mutual funds or broker fees.
Disclaimer: Mike owns shares of BLK.