In part 1 of this dividend ratios series, I reviewed some of the most common metrics used by dividend investors today, and what these metrics lack in telling us the entire picture of a company.
Parts 2 and 3 introduced two dividend ratios to better evaluate how a company truly performed and how this translated into a dividend income stream for shareholders. I called them the Business-based dividend growth rate and True Payout Ratio.
You can go back to read or review those parts here:
Dividend Ratios Pt. 1: Evaluating the Dividend History of a Stock
Dividend Ratios Pt. 2: How to Identify Sustainable Dividend Growth
Dividend Ratios Pt. 3: Measuring a Stock’s True Dividend Payout Ratio
Dividend Ratios Pt. 4: Combining Two New Metrics & Putting It All Together
In this last dividend ratios series post, part 4, I’m going to talk about how to combine the two new metrics for a proper evaluation.
No one metric is the end-all be-all, and if you want to get the whole picture of a stock you need to look at it from multiple angles.
Combining The New Dividend Ratios
Here we want to understand that the two metrics both serve a different purpose. The True Payout Ratio is more of a supporting metric, and the BB Div G is going to be the center of attention. But without the checks and balances of the True Payout Ratio, it can unfairly reward companies that are scrooges with their capital. You need both together.
What I propose is this. Say you’re running a screen for these metrics.
You’re going to want to sort the BB Div G from highest to lowest. The ones near the top will be the ones you want to target for investment. But in the column next to it will be the True Payout Ratio. Those companies that fall outside of that 25-75 range should probably be avoided.
You can use some discretion with this range depending on your goals and risk tolerance.
The lower your risk tolerance, the lower you probably want to put that upper bound, the 75. Maybe you have a higher appetite for risk and want more income, and are okay with a True Payout Ratio of 80 or higher.
Maybe sustaining the income level is more important to you and so you want a True Payout Ratio of 65 or 70 as the max.
You can use that same logic on the lower bound too. Maybe you’re really targeting higher income levels and won’t be happy with a conservative 25, and want to see at least 35 or higher. Or maybe you’re happy sacrificing income today if the BB Div G is truly outstanding, and would be fine with a 15 or 20 lower bound.
Whatever the case may be, it’s critical to be examining both sides of these metrics and getting a better picture of what’s been going on lately with a stock’s dividend history.
You might also notice that I didn’t include yield in any of these metrics. While yield can and does make an impact on the income an investor receives and thus the overall return an investor will achieve, remember the reasoning behind these metrics in the first place.
We’re not trying to pick the best stocks from a return standpoint necessarily, what we are trying to do here is evaluate managements and the underlying businesses.
A business can’t control how the stock market will react to their results, it can only control how it much it pays in a dividend from its EPS and how much those components grow over time.
If anything, these two metrics should just be another tool in an investor’s arsenal to be be combined with valuation metrics to find the best stocks for that investor.
A Dividend Investor’s Plea…
And here’s where I’d like to make a plea. This one is to the reader. I have a lot of stakes in the fire and little time to pursue all of them. I only wish I could take this idea and really flesh it out with substantial research like I did with the Value Trap Indicator.
But here’s where you can come in. Maybe this post can be a springboard for future discussions. Maybe it’s an idea that can be shared and spread to inspire other investors to take action.
I’m sure there’s developers out there with access to datasets who can create screens based on these metrics to analyze many stocks in a short period of time and create some sort of ranking system based on how they perform with these metrics.
There might be some of you with the ability to create backtests to verify these metrics and look for correlations or lessons on how much or to what extent these metrics identify businesses that either have done well in the stock market or are positioned to do well.
Maybe these metrics are a better measure of reliable streams of income for investors regardless of what happens on Wall Street with the share prices. Maybe not.
If I’ve described you and if you decide to take this idea further, I hope you’ll reach out to me. You can find me at [email protected], and while I get a ton of email already– something about this idea is very likely to catch my attention.
Or… maybe you’ll just take this information and vote silently with your dollars. That’s great too.
I’m hoping many of us can make decisions like that, so that managements can observe a tangible financial incentive to both reward shareholders and grow businesses prudently.
I just don’t see how that’s bad for anyone.