For the longest time I would create a watch list and then wait until the following month to write a post about which stock I bought and why. After rethinking how I treat this account last week I am going to change it up going forward. I never really waited between creating the watch list and making my purchase – I would write the post one night and then the next day buy my lot(s).
My Screening Method for Under Valued Dividend Growth Stocks
Earlier this year, I finished Tobias Carlisle’s book, The Acquirer’s Multiple, and decided to give the valuation method a chance. The method was very different than what I had been previously doing for the past couple of years. It focuses a lot less on using price as the main metric (price to earnings, price to book, etc), and more on the balance sheet and earnings.
Despite really enjoying the book, I decided to use a slightly different formula, the Magic Formula by famed hedge fund manager Joel Greenblatt. The reason I made that decision was not because I believed one guru over the other it was simply because of what I could obtain in a free screen. I am in the middle of Mr. Greenblatt’s book, The Little Book that Still Beats the Market, and hope to write a lot more about it next month.
What is the Magic Formula
The Magic Formula,
is a quant screen…that identifies great companies selling at a discount. The process is simple. To identify great companies Greenblatt screens for companies with a high return on invested capital (ROIC). And to identify companies that are “cheap” Greenblatt uses the company’s earnings yield.
The formula is basically Enterprise Value/EBIT. Enterprise Value is,
a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents
is an indicator of a company’s profitability, calculated as revenue minus expenses, excluding tax and interest. EBIT is calculated as:
EBIT = Revenue – Operating Expenses (OPEX)
or
EBIT = Net Income + Interest + Taxes
EBIT is also referred to as Operating Earnings, Operating Profit, and Profit Before Interest and Taxes (PBIT).
How Did I Screen for the Magic Formula?
After way longer than I’d like to admit I found an amazing, free site to easily screen for EV/EBITDA (rather than EBIT). The site is called FinBox and I would highly recommend it for anyone that is trying to screen for almost anything. The EV/EBIT is a premium feature on the site, and I may opt to sign up for the service in the future, but right now, I am just learning about this method of valuing companies.
My July 20108 Dividend Growth Watch List and Purchase
So after screening for those companies with a magic formula of less than 10, and a dividend yield of at least .01%, I was left with approximately 577 companies. Separately, there were about 165 companies that have increased their dividend at least 20 years. When we cross referenced the two lists I ended up with only 20 companies!
Narrowing the Watch List
- ADM Archer-Daniels-Midland Company
- T AT&T Inc.
- CVX Chevron Corporation
- EV Eaton Vance Corporation
- XOM Exxon Mobil Corporation
- BEN Franklin Resources, Inc.
- MGRC McGrath RentCorp
- NC NACCO Industries, Inc.
- NFG National Fuel Gas Company
- NUE Nucor Corporation
- SCL Stepan Company
- TGT Target Corporation
- TDS Telephone and Data Systems, Inc.
- UGI UGI Corporation
- UVV Universal Corporation
- WBA Walgreens Boots Alliance, Inc.
- WMT Wal-Mart Stores, Inc.
- BPL Buckeye Partners L.P.
- ENB Enbridge Inc
- CAH Cardinal Health, Inc.
To further narrow the list, I respected the formula which states to remove financials and utilities. I also removed any stock with a 2% or less dividend yield, any stock with a 20+ P/E (old habits die hard), and all health care companies.
This left me with the following companies:
Ticker & Name
- ADM Archer-Daniels-Midland Company
- T AT&T Inc.
- MGRC McGrath RentCorp
- NUE Nucor Corporation
- TGT Target Corporation
- TDS Telephone and Data Systems, Inc.
- WBA Walgreens Boots Alliance, Inc.
- WMT Wal-Mart Stores, Inc.
I then looked up each companies outstanding shares. I wanted to see either a visually decreasing number outstanding share amount.
This further reduced the stocks to:
- ADM
- TGT
- WBA
- WMT
Having a position in TGT already, and watching it explode in the past 3 months has makes me less excited about jumping in with the three consumer based companies (Walgreens and Walmart being the other two). In addition, I just started building my position in ADM with one and a half lots purchased (15 shares ~$720), and as such, I am going to purchase another lot and a half this month (16 Shares for ~$760).
Thanks for sharing. Your processes of elimination seems to be quite sound. Wish you all the best with the investment.
Thanks!
Nice article. I used to spend WAY too much time on Seeking Alpha reading about everything investing. At first, it was really beneficial because I learned the basics of finance and analyzing companies. But I reached a point of diminishing returns, so I’ve started to wind down my time on SA lately. However, I still have an interest in keeping a smaller portfolio of dividend growth stocks. I think I’ll switch to your monthly update instead!
I have mixed feelings about Seeking Alpha. The good thing is you can read about well thought out reasoning for both sides of a trade or investment…and the bad thing is you can read terribly thought out reasoning for both sides of a trade!
For me, the goal is to build an income stream that can be turned on one day (vs just being reinvested for free). Something, that when I wake up every quarter there is cash for my family. Truly passive income that was built on a shit ton of work today.
4 great companies. I like your method for narrowing down the companies. Hopefully you can pick up shares in one of those companies! WBA is intriguing to me right now, but who knows how they will hold up in this new Amazon environment. But hey, KR is still standing after the Whole Foods acquisition, right?
Bert
I ended up adding to my ADM position that I started last month. I am going to keep with this method for a year or so and then do something else, but always living in the dividend champion world