Month: June 2024

Not every stock on ‘The List’ ends up in our dividend growth investing (DGI) portfolio. ‘The List’ is a teaching tool that screens for candidates based on a set criterion across the universe of dividend growth stocks in Canada. To end up in our portfolio a candidate would need to score high on ‘quality’ using our many quality indicators. Then and only then would we look at valuation.

Despite the superior quality of our dividend growers, we exercise caution and do not initiate or augment a position unless the stock is ‘sensibly priced.’ Here are the four methods we use to assess valuation. 

1. Historical Fundamentals
2. Dividend Yield Theory
3. CAPE Ratio
4. Graham Value 

In today’s post we will review the ‘historical fundamentals’ method of arriving at a sensible price using Fortis Inc. (FTS-T), one of the highest quality candidates on ‘The List’. 

Historical Fundamentals 

A company’s operating results will determine its stock price in the long run. Analyzing a company’s historical fundamentals provides insight into how the business has been valued over an extended period. Many of the stocks we invest in have a ‘narrow valuation corridor,’ meaning the stock price follows a path that rarely deviates from its historical trading range. A company’s P/E (Price to Adjusted Operating Earnings), OCF (Price to Operating Cash Flow), EBITDA (Price to Earnings Before Interest, Taxes, and Amortization), and Sales (Price to Sales) ranges tell us a lot about how a company has been traditionally valued.

Purchasing at the bottom of these ranges or selling at the top has helped us manage our entry and exit points to enhance returns.

We use the Fundamental Analyzer Software Tool (FASTgraphs) to visualize how a company has been historically valued. We like to see it trading within its typical ‘valuation corridor’ based on a ten-to-twelve-year timeline. This gives us a clearer picture of how the stock has traded in different economic cycles.

FASTgraphs – “FG” 

The following colours/lines on the “FG” chart shown below represent: 

• Black line: Price
• White line: Dividend
• Orange line: Graham average of usually 15 P/E (price/earnings) for most stocks
• Blue line: Normal P/E
• Dashed or dotted lines: Estimates only
• Green area: Earnings

Our strategy and the safety of our capital hinges on the growing income generated by a select group of quality companies. While stock prices may vary, our overall income consistently increases. The downside is the need for patience for this growth. What are we waiting for? The dividend, the income, the yield.

Our strategy and our safety depends upon the growing income from a few leading companies, not the market, not a fund, nor over-diversification.

A quick test I like to perform is our “7% in 10 Years” test. This test helps identify dividend growth stocks that are attractive investments today. If your income stream (without reinvesting dividends) is projected to grow to a yield of 7% in ten years, then it has the potential to be a good investment opportunity.

In monetary terms, if you invest $10,000 today, you can expect to receive $700 annually from dividends alone within ten years. How does an investment bought today generate a 7% return on dividends alone ten years from now? The answer is that the dividend grows!

One reason I use 7% as my numerical goal is that equities have historically provided around 7% returns over the last 100 years. Generating a return within a decade equal to the stock market’s historical total return from the dividend alone demonstrates the magic of dividend growth investing.

Another advantage of using at least a decade as your investment horizon is that the distance between your purchase and current prices is typically significant.

Let’s look at an example of growing yield and its effect on price using a company on ‘The List’:

As we approach the midpoint of 2024, it’s the perfect time to start scouting candidates for next year’s list. Monitoring potential additions closely allows us to evaluate how they compare to our existing list of members.

While we’re comfortable building a portfolio of quality dividend growers from our current list, we always keep an eye on potential future candidates. This forward-thinking approach has paid off in the past, as evidenced by our early additions of TFII-N and MFC-T before launching our public-facing model portfolio in 2022, both of which have proven excellent choices.

Identifying Potential Candidates

We’ve identified six companies on the TSX that will meet our first two criteria for inclusion on ‘The List’ in 2025:

Dividend Growth Streak: At least 10 years.

Market Cap: Minimum of one billion dollars.

I was recently invited to join a prestigious investment club founded in 1979. Reviewing the club’s history and bylaws, I realized I was being asked to join the ‘Growth Stock Crowd’. I had tried this approach before and found it challenging. This prompted me to compare the differences between growth stock investing and my preferred method of dividend growth investing for our readers.

The Growth Stock Crowd

Growth stock investors aim to buy stocks at the right time, focusing on companies with rapid growth potential. The goal is to sell these stocks for significant profits and repeat this process continually. Even the most brilliant investors experience both wins and losses, averaging about 7%-9% long-term returns. Perfect market timing and stock selection are unrealistic, as no one can consistently win. Over time, investors hope to improve their skills and achieve more wins than losses.

The Dividend Growth Crowd

In contrast, dividend growth investors like me take a different approach. With years of experience, I may not consider myself extraordinarily intelligent, but I know basic math, how to research earnings reports, and how to assess valuations. More importantly, I have the discipline and patience honed from running my own business for twenty-five years.

Dividend growth investors are passionate about a steady, predictable way to build a secure financial future. Our investment time horizon is indefinite, so we remain undistracted by short-term market fluctuations. We invest in quality companies that consistently pay and grow dividends. Daily share price changes, the broader economic picture, and other details are secondary to a company’s ability to increase its dividend payments. Historically, as dividends grow, so does the stock price. This combination of growing income and capital appreciation is the secret sauce in our strategy, with annualized long-term total returns in the 10%-12% range.

Key Differences Between Growth and Dividend Growth Investing

Growth stock investors juggle multiple factors: selecting the right stocks, assessing current prices, evaluating company products, and timing the perfect sale to make a profit. This process must be repeated continually with different companies.

On the other hand, dividend growth investors focus on ensuring that their chosen companies will continue to pay and increase dividends annually. Lists of companies that have increased dividends for over ten years, even during tough times, are readily available. We follow one such list on this blog every week.

While growth stock investors sell their stocks to realize profits, dividend growth investors rarely sell because doing so would reduce their growing income. This income can also be reinvested in sensibly priced dividend growth companies to increase our returns.

Wrap Up

I plan to attend the investment club’s next meeting to learn more. Life has taught me that personal growth comes from stepping out of your comfort zone occasionally. At the very least, I will meet some interesting people passionate about investing.

Last week, we shared our latest quarterly and second-year financial results for the MP Wealth Builder Model Portfolio (CDN). PAID Subscribers can access the full document in our ‘Premium Content’ section and receive DGI alerts whenever we buy or sell within the portfolio. Here are some highlights:

In the quarterly review, I reiterated our approach as DIY dividend growth investors:

This is about buying businesses, not just stocks.

Trusting Canada’s top companies, led by exceptional management teams and supported by thousands of dedicated employees, is key to achieving financial freedom.

We consider our portfolio an asset management business, with our assets being the many dividend growth companies we own. Our plan is to shift from working for our investments to managing our assets and growing our ownership in the investments that work for us.