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Tue. Oct. 6, 2009

Three Dividend Stocks With A Perfect Risk Score *

A good system continues to improve itself. I maintain an extensive database with a minimum of 10 years of information on each of the 110+ stocks that I track. This data is gathered from various sources deemed reliable.  Most data is generic and can be pulled from various sites. That is except some S&P risk and quality information (RQ).

Gauging the relative risk of one stock compared to another is important when deciding which stock to buy or how much to weight a stock within your portfolio. Recently, during a scheduled site maintenance event on my broker’s site, S&P reports were temporarily unavailable.  This made me question if I really wanted to rely on propriety financial information that was not readily available from multiple sources. Ultimately, I decided it was not a good thing. To remedy this situation, the RQ portion of my risk calculation was modified as such:

For the Risk portion, I opted to focus on consecutive dividend increases. The logic here is the longer a company raises its divided, the more committed it is to dividend increases and is less likely to stop unless dire financial circumstances dictate it. Instead of relying on S&P’s Qualitative Risk Assessment (Low, Medium and High) to assign a risk rating, I will now use the following to assign the A, B or C risk rating:

  • A Risk Rating is assigned to companies that have increased their dividends for greater than 25 years.
  • B Risk Rating is assigned to companies that have increased their dividends for 15-25 years.
  • C Risk Rating is assigned to companies that have increased their dividends for less than 15 years.

As for the Quality portion, I decided on use the company’s financial quality by focusing on Free Cash Flow payout and Debt to Total Capital. Instead of using S&P’s Quality Ranking (A+, A, A, B+, B, B-, C, D and Not Ranked) to assign a quality rating, I will now use the following to assign the 1, 2 or 3 quality rating:

  • 1 Quality Rating is assigned to companies if their Free Cash Flow Payout % is less than 60% and if their Debt to Total Capital is less than 45%.
  • 2 Quality Rating is assigned to companies if the sum of their Free Cash Flow Payout % plus their Debt to Total Capital is less than 100%.
  • 3 Quality Rating is assigned to companies if the sum of their Free Cash Flow Payout % plus their Debt to Total Capital is greater than 100%.

Making this change to the 110+ companies I track. Here is what I found:

  • Overall the new method produces lower risk scores.
  • The overall risk rating on my income portfolio went from 1.78 (medium) to 1.68 (medium).
  • High risk stocks went from 7 stocks to 4 stocks.
  • Medium risk stocks went from 77 stocks to 54 stocks.
  • Low risk stocks went from 27 stocks to 53 stocks.

Excellent, low risk stocks evaluate the same under both systems. For example, the following three companies had a perfect 1.00 score under both systems:

While 60 companies improved their position, 19 companies ratings slipped under the new system. Below are some of the more notable changes:

  • Pepsico Inc. (PEP) went from a 1.00 (low) to 1.25 (low) – Analysis
  • United Technologies Corp. (UTX) went from a 1.25 (low) to 1.50 (low) – Analysis
  • Exxon Mobil Corp. (XOM) went from 1.50 (low) to 1.75 (medium)
  • Colgate Palmolive Co. (CL) went from 1.50 (low) to 1.75 (medium)
  • International Business Machines (IBM) went from 1.75 (medium) to 2.00 (medium)

The RQ portion of the risk rating is 50% of the calculation. The remaining two pieces are Current Price vs. Calculated Price and Dividend Yield. These are unchanged and their part of the risk rating calculation is discussed in Refining Risk Measurement Of Dividend Stocks.

Full Disclosure: Long JNJ, PEP, PG, UTX, WMT. See a list of all my income holdings here.

(Photo: sean carpenter)


8 Responses to “Three Dividend Stocks With A Perfect Risk Score *”

  1. Brandon says:

    I’m thrilled that you have re-worked the risk score calculation. I love your blog and your analysis process, but your risk score calculation has always been very opaque and mysterious to someone without access to the S&P reports.. until now.

    How do you determine your Debt to Total Capital values? I understand Debt to Total Capital = (equity) / (equity + debt). But when I calculate this ratio from Morningstar or Yahoo finance data, my result often disagrees with yours by upto 10%. Do you add any twists to your equation?

    Thanks,

  2. Brandon: I use Morningstar data. The lines I pickup are: (short term debt + long term debt) / (short term debt + long term debt + equity) from the “latest Qtr” column.

    Best Wishes,
    D4L

  3. Artie Cab says:

    What’s wrong with PCM as a dividend paying stock, or at least a fund, traded like a stock.

  4. Artie Cab: I have never looked at PCM. Recently. I have cooled some on ETF and closed-ended funds due to the volatility of their dividends. I see that PCM has paid $0.07/share since 2007.

    Best Wishes,
    D4L

  5. Mihou says:

    Hi Dividends4Life,
    What do you think about FTR and what is its yearly dividend rate

  6. D4L says:

    Mihou: I have never looked at FTR. I see it is paying $0.75 dividend that is yielding 8%. As noted, I don’t know anything about this company, but historically media companies have not been the best dividend growers.

    Best Wishes,
    D4L

  7. fredtheturd says:

    FTR just reduced their dividend to $0.188/share from $0.25/share in August 2010. It had been flat at $0.25/share since November 2004 before that.

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