"Dirty 30" Evaluation Tool Part 7

This has been quite a trek over the past 1.5 months and now we are starting part 7 of the D30 series. Only a few more left! Anyways if you haven't read the previous posts in the series yet then you can find them here:
Part 1
Part 2
Part 3
Part 5
Part 6

Today we will be discussing how I analyze the value of the a company's dividend. Considering that I am trying to gain passive income, a company's dividend is extremely important to me. We will go over all the variables that I take into account to develop an understanding about a companies dividend.

As always here is the Hormel (HRL) D30 Analysis we will be working from...



Let's get right into it.


Dividend Yield

A dividend yield is simply the dividend amount paid yearly divided by the current price of the stock. HRL had a 2.09% dividend yield at the time of evaluation which doesn't quite meet my expectations. What does meet my expectations? My magic number currently is over 3%. But why is it 3%? Let me explain.

When looking at creating passive income, or income that pays me while I spend as little time as possible looking after it, I am always going to invest in what is most advantageous to me. In terms of the fight between let's say a 10yr bond and dividend paying stock I look to see what is the current yield. Right now the 10yr bond stands at 2.36% which means I need to look higher to obtain a greater return. 3% is  a nice clean number almost 7/10ths higher than bond levels and makes a nice floor.

"Wait that's it?"

In the word of Lee Corso "Not so fast my friends." There is a lot more that goes into the 3% mark. Here is a link to a great article by Sure Dividend about 3 quality companies Coca-Cola (KO), Johnson & Johnson (JNJ) and Exxon Mobile (XOM):


As you can see (although this was done with only 3 companies) these companies really trounce the S&P returns when they reach 3% or higher. (To be fair these companies kind of do it anyways...). Need a more scientific method? 

Here is a link to a paper written by Heartland Advisors: 


In this they reference Dartmouth professor Kenneth French and a study he performed on dividend paying stocks and their returns based by tier of yield. When split between 5 quintiles of yield (Quintile 1 = lowest, Quintile 5 = highest) Tier 4 actually came out to be the most historically profitable followed by quintile 5 and 2 respectively. What I find most interesting though is that the standard deviation of returns actually comes between tiers 2 & 3. If we look at a rough split of the S&P 500 circa 2014 it appears like this:

SOURCE: http://www.dividend.com/how-to-invest/the-sp-500-a-dividend-overview/

SOURCE: http://www.dividend.com/how-to-invest/the-sp-500-a-dividend-overview/

Yes this isn't an exact replica of French's study in the 5 split but it's a nice visual. If it was his you would actually have it skewed at under 1%, 2%, 3% 4% and over 4%. Anyways you get the picture. If you reference the S&P yield of 2014 in comparison to his study you will find that the 4th quintile would roughly workout to that 4% yielding stock and the 3% yielding stocks would have a low deviation of volatility. That is precisely where I have reached my 3% floor when evaluating advantageous yields!



For those of you that don't know the payout ratio of a company is simply the dividend paid per share divided by earnings per share. This number indicates a certain percentage of earnings that is payed out to shareholders via the dividend.

But how much should a company be rewarding shareholders with? Typically I look for companies that have a payout ratio of 60% or less. This means that while they are rewarding shareholders with a dividend they also are leaving almost half (or more) of their earnings to invest back into the company to help with earnings growth. This obviously doesn't apply to things like REIT's that have an obligation to payout 90% of their earnings.



I have split the dividend growth rate into four categories: 10 year, 5 year, 3 year, and 1 year. These all give a bit of look inside just how long the dividend has been growing and at what rate. I currently look for a minimum of 5% growth in each of these categories. Why? Because a 5% growth rate over 10 years means that you have doubled your dividend per share!

How powerful can these returns be? Let me show you.

Here are the historical returns of Dividend Aristocats (25 years of growth) as compared to the S&P 500:

SOURCE: https://www.marketwatch.com/story/dividend-aristocrat-stocks-post-almost-double-the-returns-of-the-sp-500-in-2016-2016-09-06

SOURCE: https://www.marketwatch.com/story/dividend-aristocrat-stocks-post-almost-double-the-returns-of-the-sp-500-in-2016-2016-09-06

That's pretty nice right! Well how about the Dividend Kings (50+ years of growth)?

SOURCE: https://www.simplysafedividends.com/dividend-kings-list/

SOURCE: https://www.simplysafedividends.com/dividend-kings-list/

Now that is outrageous right? There is simply nothing better than those dividend growth stocks is there?

Well hold your horses a bit here. Just because they are dividend growers do not mean that they are winners in comparison to the S&P. There obviously are companies that do much better than others and that is why it is important to look at a lot of other variables than purely dividend growth.


3yr average buyback ratio

This is a little metric that I get from www.gurufocus.com. This is a great site with a lot of easy to read information and I encourage you to check it out if you get a chance. This metric is pretty simple, it is a measure of a company's rate of share buybacks over the past three years. A positive ratio means that the company has been buying back more shares than they have issued  (total float is decreasing) and a negative ratio means that the company has been issuing more shares than they are buying back (total float is increasing).

Why is this important? Well in terms of earnings per share a company will be able to increase this number by either increasing profit or by decreasing the number of outstanding shares. This helps with a payout ratio and also with a stocks P/E ratio. Also when dealing with companies that pay a dividend the less shares there are the less money goes to dividend payments. This means that that if a company is diligent on returning money to shareholders then you may see a higher dividend growth as shares decrease in number.




As you can see the variables that have to do with a stock's dividend payments are very important to me and also very important to the performance of the stock's return. If you take into account all of the variables listed above then you will have a good understand of a company's dividend and just how it may affect them in the future.

As always leave me any feedback below!