I think the question that I get most from readers is what method of evaluation I use to choose the select stocks that I feel really fit the mold for the Cookie Jar portfolio. After all, it should be the most important question for any dividend growth investor. What really matters to me? What do I hate most and try to avoid?
These are all good questions and they are of utmost importance to me as well. Let's not forget how I started in this direction of stock trading. I came from a beginning of failure - of losing a large portion of what I invested in because I went blind after the big numbers and failed to really realize what I was putting my time and effort into. I knew then as I keep in mind today, there are important numbers to care about in Wall Street and there are others than can be avoided and forgotten.
My Method of Evaluation
If your eyes don't immediately draw towards dividends, you shouldn't be a dividend growth investor. It's the key item that we care most about and it is the thing we should constantly, even after buying in, keep our eyes on. Does the company we are interested in pay dividends? How much do they pay in dividends annually? Have they had a history of paying dividends or did they just start? Have they ever paid a special dividend? Are they a qualified dividend payer or an unqualified payer?
These are the questions you should be asking yourself when you first dig into a stock. If a stock pays a dividend, move on to how much they pay, then how long they have been paying dividends, and so on and so forth. If these questions cannot be answered easily or positively, stop here and move on to the next company. There are great companies out there that don't pay dividends but those are not the companies that we will be looking for if we are to be dividend growth investors. We need to keep our eyes on the prize. I typically look for companies that have been paying dividends for at least five years and have had little/no breaks in their dividend payouts. They can pause their dividend raises as long as they once again resume in a short time period.
The next most important question is when they will be paying their next set of dividend payments. This is denoted of course by the ex-dividend date. This is only here to amp up the excitement of buying a new stock and is not as important as other items but it falls here because it is usually listed side by side the dividend payment amount. If a company is about to pay a dividend in the upcoming weeks or days, this is a little bit of added portfolio cookies that can be used to offset any trade fees we may pay to acquire them and also it further amps up our payout for the year in our portfolios. Again, this is not necessary but it does add a little bit to our judgement when we decide whether the time is right to buy in to a stock.
The price to earnings ratio is very important and it says a lot about a company. We all know that it is used to measure the current share price to its earnings per-share but what does it really mean for a company? How do we use it and what number range are we really looking for to qualify it for our Cookie Jar? I personally like to look for lower numbers in the P/E ratio. It tells me that I'm not buying a stock that is far over valued. On the contrary, I also make sure that it is not below eight. Currently, I prefer to look for stocks that trade within the 10-20 range for P/E ratio as they would appear to be the best valued - not suspiciously under priced and not over priced either. I do however look towards those who may dip down to as low as eight if only to look for stocks that have gone on a fire sale but are still a good company with a lot of room for dividend payouts and time to bounce back.
Stock Price and 52 Week Price Range
The next step is to look at the range of stock price to see if the company itself is trading on a discount. This attempts to solve the age old question of whether investors can truly try to time the market. There are those who argue that it's impossible to time the market but to those people I say bugger off. If a company has passed the initial questions of dividends and P/E ratio, they can move on to the question of price. I'm specifically looking for stocks that are currently trading on a discount. Our main motive should always be dividend payouts per share and that means that getting a great company on a discount means that we get even more dividend payouts if the company is on discount. I eye the 52 moving price range and see where the stock sits on the range. If it's far to the bottom of the range or at least in the lower half, it's passed the test. It can be considered discounted and therefore can be moved on to the next step.
Only after the other steps have been passed do I move to some of the pieces of fundamental analysis. When we've moved to this step, I first turn my eyes to the balance sheet. How are their cash and short term investments? Are they going up? Are they fluctuating? I prefer to aim for a stock that has an upward curve on their balance sheet, income statement, and cash flow statement. If they have an upward moving balance sheet, I move to the income sheet and make sure it's the same and then on to the cash flow sheet and make sure it also moves upward. If it consistently moves downward, you're likely looking at a company that is on a downward spiral that we don't want to get on. It's as the old saying goes (I was recently reminded of this), "don't try to catch a falling knife" - you may just get stabbed. There is an equal shot that you'll get a huge payout as there is a failing company that may never again gain its bearings. If on the other hand, there are small fluctuations, I will pull up their history and see when they were low to see if there were any significant events that describe why they took a hit on one year but not the next. If the momentary drop makes sense and can be dismissed as normal, I allow the stock to move on to the next step.
EPS - Earnings Per Share
After the sheets have been looked at, it's good to take a quick check of the company's EPS. We would like this number to be higher so that we can be comfortable knowing the company has a well rounded price per share. I don't want to be buying into a company that can't seem to make more money per share. I want the company I invest in to be one that consistently makes more and therefore earns more value per share. This step is to avoid investing in a company that simply issues more shares whenever they're in a bind.
Mr. Market can be a giant douche bag sometimes when it really shouldn't. There are many companies that fair very well on their fundamentals and continue to be a great company in many other respects even though some angry soccer mom (or dad) decides to try to nuke their name and drag it through the dirt over something that ultimately doesn't affect the companies bottom line. This then causes the stock price to drop because certain investors believe that if a company gets a bad reputation on the media, it somehow stops being a good company. Take GAP for example; they were in the media lately over a controversial shirt that was made for kids that played the wrong note to some job sectors that felt insulted over it. The company's bottom line wasn't affected but the stock took a momentary bounce in the wrong direction over the feel of the media that it was for whatever reason no longer a good company to invest in. If you're a great dividend growth investor, you will take advantage of these situations. When I see something like this and the stock has passed my earlier tests, I throw cash at it while it's down because it will undoubtedly rebound in my favor after a short while once the media moves on to its next victim.
This is the strategy that I use to pick the stocks that I want to invest in. I'll admit that it's smaller than most but I've found that it works very well for me. I by no means post this to tell all of you readers that this is the one and only way to make money as a dividend growth investor. I only post this to show you how I have found my little corner of dividend investing and how I make it work for me. If you like it, feel free to use it. If you don't, that's fine as well - it's a free country (AMERICA!!!!).