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Wed. May. 12, 2010

The Secret To Finding The Best Dividend Stocks *

Is a stock with a 3% yield and a 9% dividend growth rate better than one with a 7% yield and a 1.5% dividend growth rate? Last week we looked at yield-on-cost (YOC) and how it can be used to track the progress of a growing dividend of an individual stock. However, it is not a good metric for comparing multiple dividend stocks with each another. For this I devised a metric I call NPV MMA Differential.

Calculating A Dividend Stock’s NPV MMA Differential

The basis of this calculation is a hypothetical $1,000 investment in a stock and a Money Market Account (MMA) earning earning a 20 year average rate (I use a 20 year Treasury as a proxy).  The value calculated is the net present value (NPV) of the difference between the dividend earnings of this investment and the interest income from the MMA over 20 years.  Other assumptions include: 1.) dividends grow at the calculated dividend growth rate, 2.) dividends are reinvested, 3.) share price appreciation is not considered, 4.) interest income is reinvested in the MMA. The dividend growth rate used is calculated as the minimum dividend growth rate of the 1, 3, 5, 7, 10 year dividend growth rate or 15%, if dividends grew on average in excess of 15% for each consecutive 4 year periods, within the last 10 years of history.

Interpreting The NPV MMA Differential

The calculation takes into account the time value of money, thus if it takes too long for the stock’s dividend yield to exceed the MMA rate, then the calculation will return a negative value. This means you are financially better off to put your money in the MMA. If the dividend stock is a better investment then the NPV MMA Diff. calculated will be positive. Like dividend yield, it is desirable to have a higher NPV MMA Diff. But also like a dividend yield, if it is too high, you need to start asking why? The NPV MMA Diff. can be used to compare two or more investments.

Comparing Various Dividend Stocks NPV MMA Differential

Like all calculations, the value of the output is directly tied to the quality of the input (garbage in, garbage out). For the sake of the illustration let us consider the calculated inputs are correct and sustainable.

Which of these would you rather purchase:

- Vector Group Ltd. (VGR) with a 9.99% yield and a 3.61% dividend growth rate
- Chevron Corp. (CVX) with a 3.68% yield and a 5.95% dividend growth rate
- McDonald’s Corporation (MCD) with a 3.23% yield and a 15.00% dividend growth rate

Based on the NPV MMA Diff. they would be ranked like this:

1. McDonald’s Corporation (MCD) | NPV MMA Diff: 8,429
2. Vector Group Ltd. (VGR) | NPV MMA Diff: 6,640
3. Chevron Corp. (CVX) | NPV MMA Diff: 780

As you can see neither yield nor dividend growth is the sole determinant of value. Below are several other companies in ascending order of their NPV MMA Diff:

General Dynamics (GD)
NPV MMA Diff: (339) | Yield: 2.16% | Growth: 2.01%

3M Company (MMM)
NPV MMA Diff: (260) | Yield: 2.47% | Growth: 2.00%

Clorox Company (CLX)
NPV MMA Diff: 171 | Yield: 3.12% | Growth: 4.35%

Consolidated Edison (ED)
NPV MMA Diff: 537 | Yield: 5.37% | Growth: 0.85%

Lowe’s (LOW) | Analysis
NPV MMA Diff: 748 | Yield: 1.38% | Growth: 15.00%

The Coca-Cola Company (KO) | Analysis
NPV MMA Diff: 890 | Yield: 3.34% | Growth: 7.32%

National Retail Properties, Inc. (NNN)
NPV MMA Diff: 972 | Yield: 6.91% | Growth: 0.00%

Johnson & Johnson (JNJ) | Analysis
NPV MMA Diff: 1,245 | Yield: 3.33% | Growth: 8.42%

Raven Industries (RAVN) | Analysis
NPV MMA Diff: 1,855 | Yield: 1.87% | Growth: 15.00%

TC PipeLines, LP (TCLP)
NPV MMA Diff: 2,255 | Yield: 8.01% | Growth: 1.74%

And if you believe all the underlying inputs (which I don’t), the top stock on the list is:

Courier Corporation (CRRC)
NPV MMA Diff: 54,801 | Yield: 5.56% | Growth: 15.00%

As with any projection based on historical information, the analyst must determine the sustainability of the inputs going forward. Put another way, past performance is no indication of future results. I have always heard the luckiest people in the world are those who work the hardest. In the same vein, the secret to finding the best dividend stocks often involves rolling up our sleeves and doing our homework.

Full Disclosure: Long CVX, MCD, MMM, CLX, ED, KO, NNN, JNJ. See a list of all my income holdings here.

(Photo Credit)


3 Responses to “The Secret To Finding The Best Dividend Stocks *”

  1. Jim says:

    Interesting. As I understand the calculation, the NPV MMA Differential is at the END of 20 years. What would the graph look like on a yearly x-axis scale?

    I don’t think it would be a straight line.

  2. D4L says:

    Jim: The value is actually in today’s dollars (i.e. if all the assumptions were correct, this is the amount I would be willing to pay today for the future income stream). If you want to see the calculation it is available in D4L-PreScreen.xls located at: http://dividendsvalue.com/tools/excel-models/

    Best Wishes,
    D4L

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