Due Diligence

[Dividend Watcher]

Yes, it is a good question. The criteria I use are in my business plan. I posted it here in this thread. I'll copy them here and add some comments so you don't have to search ...

• Stocks must pay a dividend and should have been paid at a higher annual rate for more than 5 years. Use the CCC list as a primary source for investment ideas.
  
  [This is where I usually start my search although if I see something I know a little about take a big drop for no apparent reason, then I start digging in with recent news and the company's latest reports. Amgen (AMGN) was one recently and, though it's not a long-tern dividend payer, I would've bought some if I didn't have my cash allocated for others. These are more special situations than the dividend growth stocks I usually look at.]
  
• The P/E ratio for the trailing 4 quarters should not exceed 20. Additionally, it is preferable that the P/E ratio be less than or equal to the average P/E over the last 10 years. No more than 2 outliers may be excluded when calculating the average P/E.
  
  [I go back to the last 4 quarter earnings and not the the prior FY's earnings. The average P/E should tell me what Mr. Market normally prices this company at. This is versus FastGraphs ideal P/E which is too stringent for me, especially as the market keeps going up]
  
  
• Dividend yield at time of investment > 2.5% or 150% of the S&P 500 yield (whichever is higher). This excludes the Special Situation portion mentioned in the Tactics section.
  
• Dividend growth rate > 4% for the lesser of the 3, 5 or 10 year periods. Using the lowest rate of the three time frames should be a conservative estimate of future dividend growth.
  
  [If you recall, I estimate inflation at 4%. All I'm looking to do is beat it. Now what am I doing with T? Well, that's a discrepancy I'm wondering about too and think I will be revising this in the near future.]
  
  
• Payout Ratio < 70% of free cash flow (EPS + depreciation – capital expenditures) for public corporations. For some investments, such as REITs and MLPs, a higher payout ratio may be allowed provided other financial factors are deemed adequate.
  
• Current ratio should be > 1.0 and the higher the better. Some companies have operated for years with a current ratio less than 1.0.
  
  [GIS is a prime example. This is where the digging comes in.]
  
  This should be taken into account when analyzing a company's finances. Investigate cash flow, free cash flow and interest coverage to ensure the company can pay its bills and the dividend.
  
  
• Earnings Per Share (EPS), or Funds From Operations (FFO) in a REIT, increasing at a Compound Annual Growth Rate (CAGR) > 3% over the last 5 years.
  
• Debt/Total Capitalization < 50%. REITs and MLPs may exceed this due to the nature of the business. In this case, investigate debt maturity dates to ensure they're spread out over the long term.
  

As to what I use, I usually skim a few years annual reports/10Ks, read the latest shareholder letter, S&P stock report available at my brokerage, look for news from other sources, read here & SA and look for other sources at Yahoo! Finance. If there's a recent industry presentation posted on the company web site, sometimes I'll watch them. I really like videos since you can watch management's mannerisms. Is the CEO animated or excited about the company? Do other company reps share that enthusiasm, does what they are doing match what they are saying? Of course, you have to take into account some of these people are really boring and inept in these presentations but you can sometimes get a feel. Sometimes I wonder why the hell these people get paid so much and couldn't talk their way out of a parking ticket in East Podunk.

Quote:Often the glass is half full-half empty argument sends me into a tailspin. I know why I invested in Company X over company Y at that brief moment in time. Months later things have changed. If I see some red on the spreadsheet I'm hoping to learn what I did wrong. Or is it simply that Mr. Market did it to me?

This is where I like to have a 'story'. What has the company done? Why is it doing things the way they are now? Does it make business sense? Does it seem to be kingdom-growing rather than business-growing? Do I expect things to be slowing for the company temporarily? Will the company recover even if the business climate deteriorates for a while?

I think WAG was the prime example in the last few years. I've written about why I own it several times here and on SA in the comments section. The whole Express Scripts showdown, the Alliance Boots acquisition, the AmerisourceBergan agreement, the Duane Reede purchase all signalled to me that management was positioning to grow the business over the long term including overseas. WAG seemed to have saturated the U.S. market with over 8,000 outlets so they needed to do something and business-as-usual wasn't going to do it. You have to accept the "red" on your spreadsheet for a while if you expect management to transition the company.

Ensco is another. I just put that in my wife's portfolio. They are investing in more deepwater rigs with the latest technology on spec. It also seems they are trying to standardize their rigs. This makes maintenance easier (and sometimes cheaper) along with flexibility in their operations. They can take a crew from rig to rig and they're already familiar with its idiosyncrasies so they can operate it effectively. Seadrill has done the same recently but ESV's debt load was a little better and they've always seemed to be a quality company that knows their business. If you look at a lot of contract ocean drilling companies, their rig fleet is older and they don't seem to have enthusiasm that ESV has for being a quality and efficient contractor for the oil majors. Maybe I've misread it but time will tell. In the meantime, we are in the red right now.

If it's retail, have you ever shopped in the store or at it's web site? Do you like it? Do you think others would like it? I like to use TJX/ROST for this example. Their web sites aren't much (except for TJX's Sierra Trading Post where I've spend $$$$) but if you're looking for some household knick-knack, a one-off cooking utensil or some cheap clothes to knock around in, then TJ Maxx or Marshalls is my first choice to go looking. I don't want to buy junk at a dollar store where it falls apart while using it for the first couple times. We don't have any of ROST's stores around here but people say they're similar. Yes, I could go to Amazon but, if you look at how Bezos runs the company, I don't think he gives a tinkers-damn about the shareholders. You need to rely on Mr. Market for your money instead of the company. That's not what I'm looking for.

Once you've done all this, you have to be patient. Give management time to execute. Big companies take time to change or for their changes to take effect.

Sorry I wrote so much. I hope that helps with your quandary.