Sunday, June 3, 2012

A Great Time to Go Hunting for Dividends

The market downturn this past week -- indeed, over the past month -- has reignited my interest in buying stocks, and particularly dividend payers. Stocks were in general looking a bit expensive earlier in 2012 and I struggled to find many good opportunities. Frankly, I was getting a bit bored with the market and simply let my dividends roll in. Now, however, I see a number of stalwarts with strong cash flows and solid balance sheets yielding 4-5% (which, in the US is quite high) likely trading with suitable margins-of-safety and I can't help but get interested in buying up some undervalued names.

By no means am I going "all-in" here as some of the reasons for the downturn are justified -- Europe could remain a thorn in the side of the global economy for a number of years and the horrible U.S. jobs figure on Friday may have indicated a stalled U.S. recovery. Going into what will be a heated presidential election in November (and don't forget the debt ceiling debate comes up again in September), I don't have high hopes for the market the rest of this year. That said, if you have a long (10+ year) time horizon and can handle a little volatility in equities, that could make 2012 a great time to go hunting for dividend stocks -- building patiently, deliberately, and strategically, of course.

As you're shopping around for ideas, start with dividend-payers that fit this profile:

  • Yield above 3%
  • Earnings payout ratio (cover) below 50% (2x)
  • FCF payout ratio (cover) below 60% (1.7x)
  • Interest coverage (EBIT/interest expense) over 3x 
  • Sustainable competitive advantages (a quantitative sign of a sustainable competitive advantage could be consistent ROIC > 12% and double-digit operating profit margins)
  • A track record of increasing dividends (consider at least seven years of history)
  • Ideally management with a meaningful equity stake in the company

Most free online screening tools will allow you to employ these metrics in your search. I should stress that it's important to consider these metrics over a number of years and not just in 2011 or 2012 as some companies -- particularly cyclical companies -- could have had near-peak metrics recently. Again, you want to find companies that have consistently delivered strong results and can deliver sustainable results going forward. 

We may face some more market volatility in 2012, but it's absolutely essential to remain patient and focused on our own objectives in the face of this volatility. Hang in there, investors. 

A short post this week -- I plan to have something more substantive next week. A happy Jubilee weekend to my U.K. readers!