Monday, January 19, 2015

Stock purchase criteria

After a lot of thinking, here is the list of criteria of my stock purchases.

  • The stock is on the Dividend Champions, Contenders and Challengers (CCC) list (as compiled by David Fish)
  • The stock is rated B+ from S&P Capital IQ and 4 stars or more from Morning Star.
  • The Yield >3%
  • The Payout ratio < 60%
  • 10-year average Dividend growth rate at least 5%.
  • The Chowder Number >12% (8% for stocks in Telecommunications and Utilities sectors)
  • 10-year EPS in uptrend
  • stable & positive free cash flow, higher than dividend payment.
  • The stock is not overvalued. Price discount is at least 5% off fair price.
  • Debt to equity ratio is below 50%.
  • Reasonable confidence in continued dividend growth
I use Caterpillar Inc. (CAT) as an example to compare this company's data to the above list of criteria.


Criteria
CAT indicators
CAT check result
Note
Dividend CCC list
Dividend contender
V
Contender with 21 years of dividend payment.
S&P Capital IQ
4-stars
V
Buy/4-stars
Morning Star
3-stars
V
3-stars
Dividend yield
3.30%
V
Greater than 3%
Payout ratio
45.31%
V
Less than 60%
10-year dividend growth rate
12.79%
V
Greater than 5%
Chowder number
12.19%
V
Greater than 12%
10-year EPS growth rate
$5.14
V
Stable and uptrend
Free cash flow
Positive
V
Greater than dividend payout on average
Price discount
20.5%
V
Fair price $101.19, market price $84.
Debt to equity
1.50
X
Much higher than 50% criteria
 
Out of these 11 indicators, 10 of them meet the purchase criteria.  Only debt to equity ratio failed. I'll attribute this failure to the characteristic of Caterpillar's industry.  From MSN money, the industry debt to equity ratio is 1.75, while CAT's ratio is lower than industry average.  Also, CAT's return on equity and return on invested capital maintain very good rates throughout the years.

For a new company, even though the company may meet the above criteria, I'll still need to do some more research on its financial statements, annual meeting scripts, and read fellow DGI bloggers' articles.  However, for CAT, I have done research for a long time, and very familiar with its strength, so I have reasonable confidence on its capability to continue to grow dividends.

Disclosure: I currently have sold CAT Jan 2016 85 Put.  Will plan to add some shares on further price drop.

3 comments:

  1. That is a very disciplined way to invest. What I like is you are being very defensive. I HATE losing money on my purchases. More so than I enjoy earning capital gains. Your approach will be slow but, importantly, it will be CERTAIN. Devour your prey, raptor!

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  2. I appreciate this little article outlining your entry criteria. For an young inexperienced DGI like myself it is very helpful. One question - what do you use to determine "fair value"?

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    Replies
    1. Hi Ryan, Thanks for stopping by. For "Fair value", I usually look at S&P Capital IQ fair value calculation.

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