Editor's note: The Value Stock-Picking Training Program is a series of four weekly assignments. Each assignment is based on one of James Altucher's strategies in his book, Trade Like Warren Buffett. To get a copy of the book, click here.
This assignment was written by Stockpickr member Ira Krakow.
As James Altucher points out in
Trade Like Warren Buffett
Stockpickr Portfolio), Buffett's goal is to find the stocks that are most likely to go up, but which also have a "margin of safety." In other words, the greatest reward for the lowest
risk. Altucher quotes Benjamin Graham and David Dodd's book
-- the bible of value investing -- as follows: "A safe stock is one which holds every prospect of being worth the price paid except under quite unlikely circumstances." That's the real Buffett strategy.
value strategy" combines
growth. The first week of this edition of The Stock-Picking Training Program will focus on companies that consistently pay out an increasing
dividend, combined with the prospect of price
appreciation. Why? A dividend provides a "floor" for the stock price. If the price of the stock goes down, the dividend percentage increases because the denominator (the stock's price) decreases relative to the dividend amount. This attracts investors who might buy the stock for the dividend alone.
For this investment strategy to work, the dividend cannot be merely a small token. Many companies, particularly in the
sector, pay a tiny dividend so that they can pass a
screen like "companies that pay a dividend." For example,
pays 1.5% and
pays 1.7% -- not much to write home about.
With payouts like that, we're really relying more on growth in the stock price for our
profit. Instead, this week, look for companies that pay a substantial dividend that's comparable to (or better than) the
yield of a
CD or a
money market fund (currently in the 4% to 5% range). At the right stock price, companies like these could attract income-oriented investors.
Here are a few examples of such companies:
- A utility company such as Atmos (ATO) - Get Report, which pays 4.5%
- Duke Energy (DUK) - Get Report, paying 4.7%
- Citizens Communication( CZN), which pays a whopping 7.0%
- Mining company Southern Copper( PCU), which pays 5.3%
Make sure the company can actually pay the dividend. To find that out, look at the
payout ratio (the ratio of the dividend payout to the company's earnings). On Yahoo! Finance, you can find a company's payout ratio by clicking on the "Key Statistics" link on the main quote page and scrolling down to the "Dividends and Splits" section.
A payout ratio of 75% or less means that, barring unforeseen events, the dividend is probably safe. If the payout ratio is greater than 100% that's a red flag. It could mean that the company is paying the dividend by selling its
assets or by borrowing money. It's important to note that a dividend payment is entirely at the company's discretion. If the company runs into financial trouble, you could be hit with a double whammy. The dividend could be cut, or even eliminated,
the stock price is in danger of declining.
After you make sure the company's dividend is safe,
fundamental analysis must be done to determine the stock's growth prospects.
Stockpickr has many types of portfolios that focus on dividends, including the
Top Dividend Raisers by PEG. The
PEG (price/earnings-to-growth) ratio is a measure of how fast a company's earnings are forecast to grow. You can find the PEG ratio on the same Yahoo! Finance statistics page as the company's payout ratio.
The PEG Ratio, based on the estimated earnings for the next five years, displays in the "Valuation Measures" section. According to Jim Cramer, if a company is trading at less than twice its growth rate (a PEG less than 2), then the company still has room to grow. If you discover a company that consistently raises its dividend and is growing as well, you can profit in two ways: from the dividend and the increase in stock price.
So your first assignment is to pick the five best dividend plays.
Stockpickr, create a portfolio called "Dividend Plays:
Your Stockpickr Username." (To create a portfolio on Stockpickr, you'll need to first log in. If you're currently not a Stockpickr member, you can register at
www.stockpickr.com/register.) Make sure to turn the "Portfolio Tracking" feature on, so you can monitor stock prices over time.
. Pick five stocks from the Stockpickr portfolios that focus on dividends. Search Stockpickr for the many portfolios that include the word "dividend." In addition to the
Top Dividend Raisers by PEG, look at portfolios such as:
- Stocks Chosen By Bear Stearns With Dividends Greater Than 4%, a portfolio of stocks selected by the Bear Stearns Global Equity Linked Strategy team that have a projected dividend yield of 4% or greater.
- S&P Dividend Aristocrats, which consists of companies in the S&P 500 Stock Index that have consistently increased their dividend payouts. When a company increases its dividend year in and year out, that's a sign of both financial health for the company and increasing profit for you.
- Top 15 Stocks Based on Projected Three-Year Dividend Growth, a portfolio based on Bloomberg's analysis of the companies' growth -- both of stock price and dividend -- over three years.
- Dividend-Paying Soft Drink Stocks, one of many portfolios that start with a sector and narrow the selection based on whether they pay a dividend or not. If a company is both in an attractive sector and pays a dividend, that sweetens the investment even more.
Make sure to read the "Reason for picking" box for each stock in the portfolio as well for additional information. Determine whether you agree with the reasoning.
. Analyze the fundamentals of all five stocks, making sure that the
balance sheet is solid and that the company is operating in a healthy business cycle.
Also, check out the payout ratio and stock's PEG ratio. As you do this work, write your observations in the "Reason for Picking" boxes.You also don't want to be surprised by bad news, so stay up-to-date on each company. You can do this by searching for articles and videos on
. Review each stock's price history by looking at the chart over the past 10 years or from the time the company became public. Does the stock stay within a certain
trading range or do you see the price increasing over time? If its price is increasing steadily, and its fundamentals are sound, you could have a winner based on its price increase alone.
. Review the stock's dividend history. Has the company increased its dividend over time? If so, that's another reason to buy the stock, for the prospect of increasing income.
. Monitor your Stockpickr dividend portfolio of five stocks for a few months, checking the price and dividend activity once every two weeks. You want to make sure that your reasons for buying stand the test of time. Remember, you're looking for a company that actually pays the dividend while the stock price is increasing.
With this dividend play strategy, you're not looking to score a quick hit. You want to buy and hold the stock for, hopefully, many years. Following a stock for a few months before buying is a way of making sure you're making the right call before pulling the "buy" trigger.
Next: Value Stock-Picking, Week 2: How to Pick Bargain Stocks
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