06-10-2015, 06:09 PM
This is a narrative version of the core strategy for my taxable account. I have mutual funds in my retirement accounts, while I do all my individual stock selection in the taxable account. Having been laid-off a few times during the Great Recession, I like the flexibility of having funds available to supplement my emergency cash.
My goal is to acquire investments that will provide an income stream for retirement, which is about 10 years away. I prefer stocks to bonds due to the ability of assets to rise in value with inflation; however, I am skeptical that the historic rate of capital gain increases will continue (discussed previously in the forum). Therefore, this strategy considers inflation, but does not consider real capital gains.
A short list of 30 stocks has been developed from which the best value stock is bought up to a market value limit of $10,000 (as adjusted by weighting). When this market value limit is exceeded, the next best value stock is bought. This is a diversification over time strategy. I consider the $10,000 market value limit as a good compromise between rate of diversification and concentration on the best value stock. When all 30 stocks meet the market value limit, the limit will either be raised or additional stocks added to the short list.
The short list of stocks was developed by requiring an investment grade corporate credit rating and considering an adjusted yield parameter, a qualitative assessment of the company, and diversity of industries. The adjusted yield parameter accounts for dividend growth and debt. The dividend is extrapolated to grow for 5 years. By including the debt per share with the price, this parameter models a scenario where the company issues additional shares to replace the debt.
Adjusted Yield = Dividend x (1 + (Dividend Growth - Forecast Inflation) x 5 years)/(Price + Debt/Share)
I don't use historic dividend growth data. Forward looking data is used whenever possible. In this case, I believe that increases in payout ratio by companies (such as McDonalds) makes historic dividend growth rates suspect. Instead, I use projected earnings growth rates for dividend growth rate, but prorate the dividend growth rate when the payout ratio is above an optimum payout ratio (assumed to be 50% for most common stock).
Stock valuation is based on the stock market value and a comparison with corporate intermediate term bond yields. A stock's adjusted yield must be greater than the corporate bond yield minus the current inflation rate. The market value of a stock is assumed to be where the stock's forward PE ratio equals the S&P 500's forward PE ratio. I have looked at what factors best correlate with current stock pricing. The only meaningful correlation I found was with forward PE ratio. This is also the basis for the dividend value parameter used to select the best stock value.
Dividend Value = Adjusted Yield x Market Forward PE/Stock Forward PE
Stocks are weighted by the corporate credit rating.
A- to AAA = 1.0
BBB+ = 0.8
BBB = 0.5
BBB- = 0.2
<BBB- = 0
A stock will not be sold simply because it is overvalued. Selling of stock is done with the intention of avoiding capital loss or impairment of income. A stock will be sold for the following reasons:
Fraudulent accounting has occurred
The dividend has been cut
Payout ratio is greater than 1
Book value is less than 0
Credit Rating is less than BBB-
Trimming is done to reduce exposure due to temporary weakness in the stock fundamentals. If the change is judged to be permanent, selling the stock will be considered. A stock can be trimmed to the weighted market limit for the following reasons:
Dividend growth rate is less than the forecast inflation rate
Payout ratio is greater than 80%
Debt per share is greater than market value
Credit rating has been reduced
My goal is to acquire investments that will provide an income stream for retirement, which is about 10 years away. I prefer stocks to bonds due to the ability of assets to rise in value with inflation; however, I am skeptical that the historic rate of capital gain increases will continue (discussed previously in the forum). Therefore, this strategy considers inflation, but does not consider real capital gains.
A short list of 30 stocks has been developed from which the best value stock is bought up to a market value limit of $10,000 (as adjusted by weighting). When this market value limit is exceeded, the next best value stock is bought. This is a diversification over time strategy. I consider the $10,000 market value limit as a good compromise between rate of diversification and concentration on the best value stock. When all 30 stocks meet the market value limit, the limit will either be raised or additional stocks added to the short list.
The short list of stocks was developed by requiring an investment grade corporate credit rating and considering an adjusted yield parameter, a qualitative assessment of the company, and diversity of industries. The adjusted yield parameter accounts for dividend growth and debt. The dividend is extrapolated to grow for 5 years. By including the debt per share with the price, this parameter models a scenario where the company issues additional shares to replace the debt.
Adjusted Yield = Dividend x (1 + (Dividend Growth - Forecast Inflation) x 5 years)/(Price + Debt/Share)
I don't use historic dividend growth data. Forward looking data is used whenever possible. In this case, I believe that increases in payout ratio by companies (such as McDonalds) makes historic dividend growth rates suspect. Instead, I use projected earnings growth rates for dividend growth rate, but prorate the dividend growth rate when the payout ratio is above an optimum payout ratio (assumed to be 50% for most common stock).
Stock valuation is based on the stock market value and a comparison with corporate intermediate term bond yields. A stock's adjusted yield must be greater than the corporate bond yield minus the current inflation rate. The market value of a stock is assumed to be where the stock's forward PE ratio equals the S&P 500's forward PE ratio. I have looked at what factors best correlate with current stock pricing. The only meaningful correlation I found was with forward PE ratio. This is also the basis for the dividend value parameter used to select the best stock value.
Dividend Value = Adjusted Yield x Market Forward PE/Stock Forward PE
Stocks are weighted by the corporate credit rating.
A- to AAA = 1.0
BBB+ = 0.8
BBB = 0.5
BBB- = 0.2
<BBB- = 0
A stock will not be sold simply because it is overvalued. Selling of stock is done with the intention of avoiding capital loss or impairment of income. A stock will be sold for the following reasons:
Fraudulent accounting has occurred
The dividend has been cut
Payout ratio is greater than 1
Book value is less than 0
Credit Rating is less than BBB-
Trimming is done to reduce exposure due to temporary weakness in the stock fundamentals. If the change is judged to be permanent, selling the stock will be considered. A stock can be trimmed to the weighted market limit for the following reasons:
Dividend growth rate is less than the forecast inflation rate
Payout ratio is greater than 80%
Debt per share is greater than market value
Credit rating has been reduced