In order to make an investment decision as objective as possible I use a checklist. The checklist consists of 3 groups of checks:
- Dividend History
- Company profitability & outlook
- Current stock market price
I think the groups are self explanatory – I want a company that has a good dividend paying history, that is profitable, with good prospects and is currently priced cheaply.
1. Dividend History
- For me dividend investing is all about finding quality companies, that have a long history of paying dividends. The different dividend champions spreadsheets help provide this information.
- I look for continuous dividend growth for example average growth over 5 years of more than 7%. A growth rate of 7 % will double the yield on cost after 10 years. So if I invest in a stock with a yield of 5% which grows on average 7% per year then after my target of 10 years I will be getting a 10% yield. If I had invested a full position of 2,500€ that will give me an annual income of 250€! If I have 80 of these companies for a total investment of 200,000€ then I could expect to have dividend income of 20,000€ after 10 years or about 1,600€ per month. I could certainly look at retiring on that.
- I also look for positive earnings per share growth over the previous years. The company is still increasing its earnings which will help it to increase the dividends.
- Also important is a low pay-out ratio of below 60%. This means that if earnings do slow then the company has the reserves (retained earnings) to keep the steady dividend. In addition I look at the dividend pay-out history to see if the company has been prepared to increase the ratio in order to keep the constant dividend. That underlines management’s commitment.
2. Company profitability
- Low debt means that the company is less likely to have cash flow problems when interest rates rise.
- High margins means that the company has potentially very few direct competitors. i.e. a lack of competition allows the company to charge the customers what they are able to afford rather than being forced to have price wars to retain customers.
3. Current price
I try to protect the capital investment by not buying at a high. To do this I check the following:
- The price is at least 25% below the 52 week high.
- The price is less than 10% above the 52 week low.
Of course as recent events show this check does not provide an automatic guarantee that there will be no more downward movement. Buying Shell when it was close to its low it subsequently went lower creating more new lows.
I will probably evolve this check by stating that the previous 52 week low should not have been last week or that the company should not be in a downward trend. Possibly looking at moving averages will help 50 day MA crossing above 200 day MA or something similar.
I also look at the historical price earnings to get a feeling for what the market has accepted as PE ratio in good times and bad times and compare that to the current PE. This gives me an idea as to whether the company is over or under priced as perceived by the bull/ bear market.