It’s been awhile since I’ve done a stock watch list. Over the summer I spent most of my research energy looking at bond funds, so my watch lists from May (twice), July and August were focused on that.
The last time I did a watch list of actual stocks was waaay back in March! So I guess we’re overdue.
The focus of this watchlist is on investments that would be suitable for our tax advantaged accounts. If you look at our IRA accounts (labeled as accounts nos. 2, 7 and 8 in the portfolio back at the mothership), we have nearly $17K in cash between our two Roth IRAs and the traditional IRA. Sure the market’s expensive right now, but I believe strongly that if you look hard enough, you can find good values. Plus, if things go ape-shit, it’s good to have a list of names you can be confident to act boldly with.
I publish all my watch lists at the mother ship on a single google sheet with a separate tab for each watch list.
The purpose of this post is to describe my process for how I created this latest watch list. So let’s dig right in shall we?
Universe of Stocks
I started with David Fish’s most recently published (9/30/16) list of Dividend Champions, Contenders and Challengers (CCC). That gave me a universe of 778 stocks to start with.
First I have to say that Mr. Fish’s spreadsheet is freaking awesome. I don’t really know how much time it takes to put that thing together, but it’s a lot of damn work, and he publishes it for free. Every DGI investor should be extremely thankful for this free gift to the world.
But with that said, the spreadsheet gets stale quickly. The metrics like P/E, current yield, etc change with the market price, and things like EPS will change with each earnings announcement.
Fortunately a lot of those metrics can be retrieved automatically using the googlefinance function.
So the first thing I do to make my watch list, is I take the CCC list and copy and paste it into google sheets. Then I add columns for the live share price, yield, EPS, earnings payout ratio, P/E, market cap, and shares outstanding.
Filtering the Universe of Stocks – Step 1: Sort by Yield
Now that I had live values for a lot of the key metrics, I sorted the CCC list by yield percentage, highest to lowest. I did that this time because the point of this watch list is to focus on stocks for our tax advantaged accounts, so that means I’m leaning towards higher yielding issues.
Of course when evaluating stocks, you want to consider total return, not just dividends, but some stocks have a bigger percentage of their total return made up by dividends than others. If you have the choice, why not put higher yielding stocks in tax advantaged accounts, while putting the lower yielders in the taxable accounts?
So I got rid of anything that wasn’t yielding 2.8% or better. I’d really prefer 3% and above, but remember, the yield listed in the watch list is “live” so it will change with the share price. I overshot my 3% target by a bit, because if the share price drops for some of those lower yielders, they could still make the cut.
So now I had a list, sorted by yield of every stock that’s raised dividends for 5 consecutive years or more. Sweet! I don’t know how many were left at that point, but it was still too many.
Filtering the Universe of Stocks – Step 2: Hand Wavy Filtering Rules – Mostly by Earnings Payout Ratio, but Stock Type Too
I have to admit, this step wasn’t super scientific. I calculated a payout ratio based on the forward annual dividend and the current EPS. I got rid of pretty much anything that was over 80% (except KO, because I wanted to look at KO). I also got rid of any REITs, MLPs, BDCs and utilities (except for ARTNA because I wanted to look at ARTNA), I also got rid of a lot of small banks and insurance companies that I’d never heard of. Sorry…I don’t have time to dig through that shit.
Since most of the REITs, MLPs, BDCs and utilities have stupid payout ratios, there was a lot of overlap with the stocks I was eliminating. I realize that those companies’ corporate structures make for “weird” earnings values, but that is part of my crisis of faith in those types of companies, which I promise I will eventually write about. For now though, I plan to use VNQ to get REIT exposure, and frankly I don’t want anything to do with MLPs or BDCs. The only utility I’m interested in is maybe PG&E and maybe some water companies (hence why I gave ARTNA a deeper look).
After this step I was left with 55 stocks, which felt a little more manageable.
Manually Enter Historical Valuation Data and Cash Flow
This is the most tedious part of the process, but it’s not too bad. I’m sure there’s a way to write some code and have google sheets do this automatically. I’m not that smart with computers. Anyone reading who knows how to do it, please contact me!
Anyway, I look up the 5 year average P/E, the 5 year average yield and the 3 year average price/cash flow from morningstar. Then I go to the cash flow statement (also at morningstar) and I get the TTM cash from operations, TTM cash used for investing, TTM capex, and TTM dividends paid.
I have cells that compare the current P/E and yield to the 5 year averages. I calculate the current price to cash flow using the TTM cash from ops, the current share count, and the live share price, and compare that to the 3 year average.
Then I calculate my version of the dividend cushion ratio using the cash flow statement data, which is basically that I just keep the cash flow parameters flat for 5 years, and assume the dividend grows at the market implied DGR for a 10% discount rate (DGR = 10% – current yield). This time I calculated the cushion ratio using both total cash used for investing and capex. Sometimes when a company has a big acquisition their “cash used” parameter unfairly distorts the 5 year projected cash, so I think it’s informative to look at both scenarios. Obviously if the ratio is above 1.0 for both cases, that is the best.
Conditionally Format the Performance Metrics Cells
After all this, I ended up with 9 columns of metrics that are key to my investment thesis process:
Payout ratio (based on EPS and FCF) – target 60% or less (mostly concerned with FCF version)
Debt/Market Cap (as a percentage) – target 33% or less
“Cash Position” – target either $1B+ or cash > debt
5 year P/E – current P/E – target greater than 0
5 year yield – current yield – target less than 0
3 year price/cash flow – current – target greater than 0
Dividend Cushion Ratio (2 calcs) – target greater than 1.0
I use conditional formatting so that cells with metrics that are within the target range are shaded green.
Select Stocks for the Watch List
Stocks with green cells across all or most of the target metrics are what make up the watch list.
This time I came up with four “tiers”, which separate the stocks into groups as a function of how many metrics they passed. In the end there were five stocks that achieved Tier 1 status; 15 stocks that made it into Tier 2; five more in Tier 3; and ten stocks that squeaked by into Tier 4.
As I mentioned already, this watch list (along with all my other watch lists created this year) is published back at the mothership, where you can browse them all at any time.
Over the next week or so, I will discuss the various tiers and stocks on the watch list in further detail. For now I just wanted to explain the method to my madness, and get the list published.
So there you go. Time to start reading some press releases eh?