The market picked up some positive momentum in January and has gained an impressive 6.5% since the beginning of 2023. As of this writing, the Fed raised the short-term interest rates by another 25 basis points, as widely expected. Further, Chairman Powell made a comment acknowledging the slowdown in inflation and the start of the disinflationary process. This immediately buoyed the stock prices up this Wednesday afternoon.
However, a lot will depend on the next CPI (Consumer Prices Index) report due to be announced around mid-February. As long as inflation continues to dip, the markets should have a decent shot at a further upside. Most market participants still expect a recession by the 3rd or 4th quarter of 2023, but most bets are off on a deep recession. Rather, expectations have risen of a shallow recession (in other words, a soft landing).
In spite of all the positive movement, this period of economic uncertainty may still last another three to six months. That’s why it is important to keep some cash reserves and dry powder to make opportunistic buys. However, it is very difficult to catch the exact bottom (or the peak), so it is best to buy good, solid dividend-paying stocks in multiple lots.
All that said, we believe it is best to invest for the long term. With that perspective, we need to pay attention to the quality of the companies that we invest in and the price we pay. Naturally, it helps to buy such companies when they’re being offered relatively cheap. The goal of this series of articles is to find companies that are fundamentally strong, carry low debt, support reasonable, sustainable, and growing dividend yields, and trade at relatively low or reasonable prices. These DGI stocks are not going to make anyone rich overnight, but if your goal is to attain financial freedom by owning stocks that would grow dividends over time, meaningfully and sustainably, then you are at the right place. The purpose is to keep our buy list handy and dry powder ready so that we can use the opportunity when the time is right. Besides, every month, this analysis is able to highlight a few companies that otherwise would not be on our radar.
This article is part of our monthly series, where we scan the entire universe of roughly 7,500 stocks that are listed and traded on U.S. exchanges, including over-the-counter (OTC) networks. However, our focus is limited to dividend-paying stocks. We usually try to find stocks that may have temporary difficulties or may have lost favor with the market and offer good discounts on a relative basis. However, that’s not the only criterion that we apply. While seeking cheaper valuations, we also demand that the companies have an established business model, solid dividend history, manageable debt, and investment-grade credit rating. Please note that these are not recommendations to buy but should be considered as a starting point for further research.
This month, we highlight three groups with five stocks each that have an average dividend yield (as a group) of 3.21%, 5.30%, and 7.55%, respectively. The first list is for conservative and risk-averse investors, while the second one is for investors who seek higher yields but still want relatively safe dividends. The third group is for yield-hungry investors but comes with an elevated risk, and we urge investors to exercise caution.
Notes: 1) Please note that when we use the term “safe” regarding stocks, it should be interpreted as “relatively safe” because nothing is absolutely safe in investing. Also, in our opinion, for a well-diversified portfolio, one should have 15-20 stocks at a minimum.
2) All tables in this article are created by the author unless explicitly specified. The stock data have been sourced from various sources such as Seeking Alpha, Yahoo Finance, GuruFocus, and CCC-List (drip investing).
The Selection Process
Note: Regular readers of this series could skip this section to avoid repetitiveness. However, we include this section for new readers to provide the necessary background and perspective.
We start with a fairly simple goal. We want to shortlist five companies that are large-cap, relatively safe, dividend-paying, and trading at relatively cheaper valuations in comparison to the broader market. The objective is to highlight some of the dividend-paying and dividend-growing companies that may be offering juicy dividends due to a temporary decline in their share prices. The excess decline may be due to an industry-wide decline or some kind of one-time setbacks like some negative news coverage or missing quarterly earnings expectations. We adopt a methodical approach to filter down the 7,500-plus companies into a small subset.
Our primary goal is income that should increase over time at a rate that at least beats inflation. Our secondary goal is to grow the capital and provide a cumulative growth rate of 9%-10% at a minimum. These goals are, by and large, in alignment with most retirees and income investors, as well as DGI investors. A balanced DGI portfolio should keep a mix of high-yield, low-growth stocks along with some high-growth but low-yield stocks. That said, how you mix the two will depend upon your personal situation, including income needs, time horizon, and risk tolerance.
A well-diversified portfolio would normally consist of more than just five stocks and preferably a few stocks from each sector of the economy. However, in this periodic series, we try to shortlist and highlight just five stocks that may fit the goals of most income and DGI investors. But at the same time, we try to ensure that such companies are trading at attractive or reasonable valuations. However, as always, we recommend you do your due diligence before making any decision on them.
The S&P 500 currently yields roughly 1.60%. Since our goal is to find companies for a dividend income portfolio, we should logically look for companies that pay yields that are at least similar to or better than the S&P 500. Of course, the higher, the better, but at the same time, we should not try to chase very high yields. If we try to filter for dividend stocks paying at least 1.50% or above, nearly 2,000 such companies are trading on U.S. exchanges, including OTC networks. We will limit our choices to companies that have a market cap of at least $10 billion and a daily trading volume of more than 100,000 shares. We also will check that dividend growth over the last five years is positive, but there can be some exceptions.
We also want stocks that are trading at relatively cheaper valuations. But at this stage, we want to keep our criteria broad enough to keep all the good candidates on the list. So, we will measure the distance from the 52-week high but save it to use at a later stage. Also, at this initial stage, we include all companies that yield 1% or higher. In addition, we also include other lower-yielding but high-quality companies at this stage.
Criteria to Shortlist:
- Market cap > $10 billion ($9 billion in a down market)
- Dividend yield > 1.0% (some exceptions are made to include high quality but lower yielding companies)
- Daily average volume > 100,000
- Dividend growth past five years >= 0.
By applying the above criteria, we got around 600 companies.
Narrowing Down the List
As a first step, we would like to eliminate stocks that have less than five years of dividend growth history. We cross-check our current list of over 600 stocks against the list of so-called Dividend Champions, Contenders, and Challengers originally defined and created by David Fish. Generally, the stocks with more than 25 years of dividend increases are called dividend Champions, while stocks with more than ten but less than 25 years of dividend increases are termed, Contenders. Further, stocks with more than five but less than ten years of dividend increases are called Challengers. Also, since we want a lot of flexibility and wider choice at this initial stage, we include some companies that pay dividends lower than 1.50% but otherwise have a stellar dividend record and growing dividends at a fast pace.
After we apply all the above criteria, we’re left with roughly 312 companies on our list. However, so far in this list, we have demanded five or more years of consistent dividend growth. But what if a company had a very stable record of dividend payments but did not increase the dividends from one year to another? At times, some of these companies are foreign-based companies, and due to currency fluctuations, their dividends may appear to have been cut in US dollars, but in reality, that may not be true at all when looked at in the actual currency of reporting. At times, we may provide some exceptions when a company may have cut the dividend in the past but otherwise looks compelling. So, by relaxing some of the conditions, a total of 74 additional companies were considered to be on our list. We call them category ‘B’ companies. After including them, we had a total of 386 (312 + 74) companies that made our first list.
We then imported the various data elements from many sources, including CCC-list, GuruFocus, Fidelity, Morningstar, and Seeking Alpha, among others, and assigned weights based on different criteria as listed below:
- Current yield: Indicates the yield based on the current price.
- Dividend growth history (number of years of dividend growth): This provides information on how many years a company has paid and increased dividends on a consistent basis. For stocks under the category ‘B’ (defined above), we consider the total number of consecutive years of dividends paid rather than the number of years of dividend growth.
- Payout ratio: This indicates how comfortably the company can pay the dividend from its earnings. We prefer this ratio to be as low as possible, which would indicate the company’s ability to grow the dividend in the future. This ratio is calculated by dividing the dividend amount per share by the EPS (earnings per share). The cash-flow payout ratio is calculated by dividing the dividend amount paid per share by the cash flow generated per share.
- Past five-year and 10-year dividend growth: Even though it’s the dividend growth rate from the past, this does indicate how fast the company has been able to grow its earnings and dividends in the recent past. The recent past is the best indicator that we have to know what to expect in the next few years.
- EPS growth (average of previous five years of growth and expected next five years’ growth): As the earnings of a company grow, more than likely, dividends will grow accordingly. We will take into account the previous five years’ actual EPS growth and the estimated EPS growth for the next five years. We will add the two numbers and assign weights.
- Chowder number: So, what’s the Chowder number? This number has been named after well-known SA author Chowder, who first coined and popularized this factor. This number is derived by adding the current yield and the past five years’ dividend growth rate. A Chowder number of “12” or more (“8” for utilities) is considered good.
- Debt/equity ratio: This ratio will tell us about the debt load of the company in relation to its equity. We all know that too much debt can lead to major problems, even for well-known companies. The lower this ratio, the better it is. Sometimes, we find this ratio to be negative or unavailable, even for well-known companies. This can happen for a myriad of reasons and is not always a reason for concern. This is why we use this ratio in combination with the debt/asset ratio (covered next).
- Debt/asset ratio: This ratio will tell us about the debt load in relation to the total assets of the company. In almost all cases, this ratio would be lower than the debt/equity ratio. Also, this ratio is important because, for some companies, the debt/equity ratio is not a reliable indicator.
- S&P’s credit rating: This is the credit rating assigned by the rating agency S&P Global and is indicative of the company’s ability to service its debt. This rating can be obtained from the S&P website.
- PEG ratio: This also is called the price/earnings-to-growth ratio. The PEG ratio is considered to be an indicator if the stock is overvalued, undervalued, or fairly priced. A lower PEG may indicate that a stock is undervalued. However, PEG for a company may differ significantly from one reported source to another, depending on which growth estimate is used in the calculation. Some use past growth, while others may use future expected growth. We’re taking the PEG from the CCC list wherever available. The CCC list defines it as the price/earnings ratio divided by the five-year estimated growth rate.
- Distance from 52-week high: We want to select companies that are good, solid companies but also are trading at cheaper valuations currently. They may be cheaper due to some temporary down cycle or some combination of bad news or simply having a bad quarter. This criterion will help bring such companies (with a cheaper valuation) near the top as long as they excel in other criteria as well. This factor is calculated as (current price – 52-week high) / 52-week high.
- Sales or Revenue growth: This is the average growth rate in annual sales or revenue of the company over the last five years. A company can only grow its earnings power as long as it can grow its revenue. Sure, it can grow the earnings by cutting costs, but that can’t go on forever.
Below we provide a table (as a downloadable Excel spreadsheet) with weights assigned to each of the ten criteria. The table shows the raw data for each criterion for each stock and the weights for each criterion, and the total weight. Please note that the table is sorted on the “Total Weight” or the “Quality Score.” The list contains 386 names and is attached as a file for readers to download.
Selection Of The Top 50
We will first bring down the list to roughly 60 names by automated criteria, as listed below. In the second step, which is mostly manual, we will bring the list down to about 30.
- Step 1: We will first take the top 20 names in the above table (based on total weight or quality score).
- Step 2: Now, we will sort the list based on dividend yield (highest at the top). We take the top 10 after the sort to the final list. We only take the top two or three from any single industry segment because, otherwise, some of the segments, like energy, tend to overcrowd (selected eleven names).
- Step 3: We will sort the list based on five-year dividend growth (highest at the top). We will take the top 10 after the sort to the final list (selected eleven names).
- Step 4: We will then sort the list based on the credit rating (numerical weight) and select the top 10 stocks with the best credit rating. However, we only take the top two or three from any single industry segment because, otherwise, some of the segments tend to be overcrowded (selected eleven names).
- Step 5: We will also select ten names that have the largest discount from their 52-week highs as long as they meet other criteria.
From the above steps, we had a total of 62 names in our final consideration. The following stocks appeared more than once:
Appeared two times:
AAP, ADP, CI, CVX, MSFT, SWK, VFC (7 duplicates).
After removing eleven duplicates, we are left with 55 (62-7) names.
Since there are multiple names in each industry segment, we will just keep a maximum of three or four names from the top of any one segment. We keep the following:
Financial Services, Banking, and Insurance:
Financial Services – Others: (MS), (V), (BLK)
Business Services/ Consulting:
Mining (other than Gold): (NTR), (BHP)
Cons-Retail: (LOW), (TGT), (COST), (AAP)
(MSFT), (QCOM), (AMAT), (AVGO)
Pipelines/ Midstream: (EPD), (MPLX), (ENB)
Oil & Gas (prod. & exploration): (CTRA), (CVX), (EOG), (PXD)
Final Step: Narrowing Down To Just Five Companies
In this step, we construct three separate lists of five stocks each, with different sets of goals, dividend income, and risk levels. The lists are:
1) Conservative Dividend list,
2) Moderately High Dividend List,
3) Ultra High Dividend List, and
4) A combined list of the above three (duplicates removed).
By and large, this step is a subjective one and is based solely on our perception. The readers could certainly differ from our selections. We try to make each of the three lists highly diversified and try to ensure that the safety of dividends matches the overall risk profile of the group. Nonetheless, here are our three final lists for this month:
Final A-List (Conservative Safe Income):
Average yield: 3.21%
Note : (EPD could be replaced with ENB (Enbridge) if the Partnership structure of EPD needs to be avoided).
Table-1A: A-LIST (Conservative Income)
Note: EPD is a Mid-stream Partnership and issues the K-1 tax form instead of 1099-Div (for corporations).
We think this set of five companies (in the A-List) would form a solid diversified group of dividend companies that would be appealing to income-seeking and conservative investors, including retirees and near-retirees. The average yield is reasonable at 3.21% compared to less than 1.6% of the S&P 500. The average dividend growth history is roughly 26 years, and the average discount from a 52-week high is very attractive for these stocks at -16.5%.
If you must need even higher dividends, consider B-List or C-List, as presented below.
ADP (Automatic Data Processing) and MSFT (Microsoft) have been selected for the reliability and growth of their dividends. Even though their current yields are low, growth should compensate in the long run.
QCOM (Qualcomm): Qualcomm is a leading semiconductor and technology company that provides a wide range of products and services for the mobile, automotive, and IoT markets. It is credited for its pioneering work in developing 3G, 4G, and 5G wireless technologies. It provides chipsets, modems, and many other hardware components for smartphones, tablets, and laptops. It also offers a range of software and services related to wireless communication, including 5G technology and the Internet of Things [IOT]. Another major source of revenue for the company comes from licensing its intellectual property and patents related to wireless technology to other companies worldwide.
Just like many other technology and semiconductor companies, the stock has done poorly and lost a lot of value in the year 2022. Due to macro headwinds, the company’s revenue and earnings are expected to decline in 2023. However, the stock valuation has become very attractive as well, with a forward P/E of less than 13 at this time. It is trading at nearly 30% lower than its 52-week high. This was also recommended in the previous month’s report and has gained nearly 15% since that time, but we still consider it a good buy.
MRK (Merck): It is one of the largest pharma companies in the world by market capitalization and revenue. In spite of its large size, it is seeing unprecedented growth in its core drugs and businesses. It has grown its revenue by 14% during the last quarter. It is also investing nearly $4 Billion a year in R&D for its next line of new drugs. However, most of this growth may already be baked into the stock price, and valuation is no longer cheap. All that said, we still see more growth going into 2023, so we can still invest in this company for stable dividends and solid growth at a reasonable price.
EPD (Enterprise Products Partners): EPD is one of the largest pipelines and mid-stream companies in the US, with a more than 50,000-mile footprint covering the U.S. Its revenue in the past 12 months has exceeded $55 billion. Moreover, the company has increased its distribution for the last 25 years and thus is included in the Dividend Aristocrat’s club. Also, the company has been buying its shares aggressively, which benefits the existing shareholders. Given its dividend track record, conservative and shareholder-friendly management, wide-moat midstream asset base, and reasonable price, it is a good choice for income investors. We will probably not get a very high rate of price appreciation from this company, but we can expect a consistent and reliable distribution income stream.
Final B-List (High Yield, Moderately Safe):
Average yield: 5.30%
Note 1: Very often, we include a few low-risk stocks in B-List and C-list. Also, oftentimes, a stock can appear in multiple lists. This is done on purpose. We try to make each of our lists fairly diversified among different sectors/industry segments of the economy. We try to include a few of the highly conservative names in the high-yield list to make the overall group much safer.
Note 2: EPD is a Mid-stream Partnership and issues the K1 tax form instead of 1099-Div (for corporations).
Table-1B: B-LIST (High Yield)
In the B-List, the overall risk profile of the group becomes slightly elevated compared to A-List. That said, the group will likely provide safe dividends for many years. This list offers an average yield for the group of 5.30%, an average of 20 years of dividend history, and an average discount of -18% (from 52-wk highs).
UPS (United Parcel Service): It is one of two duopolies in the logistics sector (the other being FedEx) and appears to be a better choice (compared to FedEx) for dividend consistency. There is nothing exciting here in terms of immediate growth except that dividend is pretty safe and decent at 3.44%. Also, the company has increased its dividend for the past 13 years. In the current macro environment, not much growth is expected in the next couple of years due to macroeconomic conditions. But over the long term, the company should do well, and in the meanwhile, we can continue to collect the dividends.
BNS (Bank of Nova Scotia):
Bank of Nova Scotia is the third-largest Canadian-based bank by assets and one of six Canadian banks that collectively hold almost 90% of the nation’s banking deposits. The company operates primarily in Canada, the United States, and Latin America. Besides Canada, in terms of market share, Scotiabank is a top three bank in Chile and Peru and is the fifth and sixth largest bank in Mexico and Colombia, respectively. Its current dividend yield is well above 6%, which is much higher than its long-term yield average of roughly 4.6%. The share price is down 34% from its 52-week high due to recession fears and slowing lending. As with any other bank, there are risks emanating from any financial shock in the markets that it operates. However, overall, due to the reasons stated above, this is a decent high dividend stock with reliable and consistent dividends at an attractive valuation point.
AVGO (Broadcom): We have included AVGO as the technology company here in place of MSFT (in the A-List). AVGO definitely has more risk than the blue-chip MSFT but also offers much higher dividend yield and growth prospects. The risk comes from its aggressive acquisition strategy, which has worked well in the past. Its most recent acquisition (pending) of VMWare for $60 Billion will add quite a bit of additional debt but would diversify more heavily in the software business.
We have added the high-yielding stock VZ (Verizon). Usually, VZ would be considered a conservative dividend stock, but due to the very high debt burden in a high-interest rate environment and slowing growth has caused the stock to decline nearly 28% from its peak. We feel the stock is offering a much better valuation and a very attractive dividend yield at these levels.
Final C-LIST (Yield-Hungry, Less Safe):
Average yield: 7.55%
Note 1: Oftentimes, a stock can appear in multiple lists. We try to include one or two conservative names in the high-yield list to make the overall group much safer.
Note 2: EPD is a Mid-stream Partnership and issues the K1 tax form instead of 1099-Div (for corporations).
Table-1C: C-LIST (Yield-Hungry, Elevated Risk)
Apparently, this list (C-List) is for yield-hungry DGI investors, so we urge due diligence to determine if it would suit your personal situation. Nothing comes for free, so there will be more risk involved with this group. That said, it’s a highly diversified group spread among five different sectors.
BHP Group: The stock is no longer as cheap as it was back in November 2022. The quality of the company remains the same, but the value proposition has changed a bit. We include it in our C-list due to the attractiveness of the dividend yield. It is quite likely that the company will reduce the dividend payout in the future (likely in 2023), by some estimates, as much as 25% to 50%. Some of the dividend reduction is already baked into the price. Even then, the future yield will still be very attractive (at around 6% to 10% on current prices). It will be best to buy this in two lots, one now and one later, if the prices drop significantly once again from current levels due to dividend reduction. This month, BHP made it to our C-List.
The company’s stock is generally more volatile because of the cyclical nature of its business. It had a tremendous year in 2021-22 because of high commodity prices. Going forward, the demand outlook may decline a bit, but overall the demand for commodities that BHP produces is likely to remain strong as more and more people move into the middle class in the developing world. Exploration and supply growth will remain constrained due to factors like environmental regulations and the ESG framework.
We may like to caution that each company comes with certain risks and concerns. Sometimes these risks are real, but other times, they may be a bit overblown and temporary. So, it’s always recommended to do further research and due diligence.
What If We Were To Combine The Three Lists?
If we were to combine the three lists and thereafter remove the duplicates (because of combining), we would be left with nine unique names. The combined list is highly diversified in many industry segments. The stats for the group of 9 are as follows:
Average yield: 4.80%
Average discount (from 52WK High): -18.34%
Average 5-Yr dividend growth: 11.55%
Average Quality Score: 56.88
In the first week of every month, we start with a fairly large list of dividend-paying stocks and filter our way down to just a handful of stocks that meet our selection criteria and income goals. In this article, we have presented three groups of stocks (five each) with different goals in mind to suit the varying needs of a wider audience. Even though the risk profile of each group is different, each group in itself is fairly balanced and diversified.
The first group of five stocks is for conservative investors who prioritize the safety of the dividend and the preservation of their capital. The second group reaches for a higher yield but with only a slightly higher risk. However, the C-group comes with an elevated risk and is certainly not suited for everyone.
This month, the first group yields 3.21%, while the second group elevates the yield to 5.30%. We also presented a C-List for yield-hungry investors with a 7.55% yield. The combined group (all three lists combined with duplication removed) offers an even more diversified group with eleven positions and a 4.80% yield.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.