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Chowder Rule
#1
The “Chowder Rule” has become a very popular metric over at SA among dividend growth investors. While the underlying concept is simple enough, and grounded in common sense, I think the “rule” derived from it is very misleading and possibly even dangerous.

The “rule” is simple enough: to find stocks that have a desirable blend of initial yield and dividend growth, add the two numbers together and determine whether they exceed a minimum threshold, which might vary by company type. If you want more detail, here is how Chowder himself explains it.

I agree that there is absolutely a balance to be considered between initial yield and dividend growth. Many dividend growth investors will only consider a lower-yielding stock if it has a high dividend growth rate. Reasonable minds may argue about this balance, and each investor will have to decide how to address these dynamics in their own stock selection.

But in my opinion, to add these two numbers together and use the result as a metric for evaluating a stock makes little sense. Just on the face of it, you are adding numbers that are entirely different. Yes, they are both expressed as percentages, but that does not mean that they are in the same “units,” if you will. Yield is the percentage of your purchase price that you will receive in dividends. The dividend growth rate is the rate at which the dividend has grown. If shares of company XYZ yield 3 percent, and the dividend has a growth rate of 10 percent, the resulting Chowder number of 13 does not measure anything. You are not getting 13 percent of anything, and there is nothing that is growing at a rate of 13 percent. The yield and the dividend growth rate are both important numbers, and there is a relationship between the two, but they must be evaluated separately in light of each other, and not falsely rolled into a single number.

You might think that I am being overly picky here, and that the Chowder number is only one of many things an investor might consider. But I think there are a lot of newer investors over at SA looking for information and guidance, especially about dividend growth investing, and having this metric touted as a “rule” is both misleading and dangerous. Indeed, I’ve generally ignored the Chowder rule, but was inspired to write this when I read this recent article that doubles down on the Chowder rule by referring to it as “Total Dividend Return.” To me, this is truly misleading and dangerous – I do not see how the Chowder number is a measurement of any type of total return that an investor might expect.

I’ve seen some suggestion that underlying logic of the rule is that the dividend growth rate is some sort of proxy for the share price appreciation that you might expect, and that is how you get to “total return.” But I’ve seen no analysis supporting this contention, and even if it is true that a high dividend growth rate does correlate to a relatively fast increase in share price, this does not mean that adding the dividend growth rate to the yield gives you any sort of a meaningful number.

Maybe the Chowder number’s meaning is obvious and apparent to everyone but me, and I’d be glad to be enlightened. But in my opinion the rule makes little sense on its face, and I think it is scary that not only does it go completely unquestioned, but seems to be taking on great significance among DG investors over at SA. Read the many comments to the recent article and you’ll see many accolades and several newer investors jumping on board with the approach. As of this moment, there are 190 comments to the article, and exactly one of them questions, gently, the basis for the rule, though that question did not seem to generate serious discussion.

To be clear, I am a fan of Chowder’s articles. He has written many excellent pieces on dividend growth investing and has helped many new investors find their footing with the strategy. Indeed, I was heartened to see that Chowder himself jumped into the comments thread of that article to note that the Chowder rule should only be applied after other important criteria were met. Chowder is undoubtedly a force for good among DG investors over at SA. I just worry that the “Chowder rule” is inappropriately becoming part of the dividend growth gospel.

What am I missing?
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#2
The one thing that jumps out at me is the fact that the Chowder Rule tends to weight dividend growth rate much higher than initial yield, in the decision making process. For a pure DG investor, that would likely make sense, especially were the investor has decades lefts before retirement. I agree with your caution, that many may tend to over use or misunderstand this very simple screening device when making investment decisions.
Alex
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#3
If you reinvest dividends, the chowder rule is essentially the compounded dividend growth rate for your dividends. So quick use of rule of 72 says with a chowder # of 14.5 you can expect your dividends to double every 5 years.

Its a quick and easy way to figure your expected dividend income growth.

I wrote an article on it last year talking about the chowder number over varying initial yields and the theoretical returns.

http://seekingalpha.com/article/1546322-...-Portfolio

As time allows later this year I'm hoping to write another updated article with more real-world examples.
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#4
(03-10-2014, 08:51 AM)hendi_alex Wrote: The one thing that jumps out at me is the fact that the Chowder Rule tends to weight dividend growth rate much higher than initial yield, in the decision making process. For a pure DG investor, that would likely make sense, especially were the investor has decades lefts before retirement. I agree with your caution, that many may tend to over use or misunderstand this very simple screening device when making investment decisions.

Not as applied by chowder it does not. I think it can be a useful guideline, one of several metrics to consider. There is so much variety in how dividend growth investors go about their work that I would hesitate to call much of anything a DGR gospel Smile

Quote:High Current Yield is defined as a yield that is at least 50% above the yield offered by the S&P 500. Therefore, if the S&P 500 has a 2% yield, then 3% is the minimum number for purchase under the formula stated above.

High Growth of Yield is defined as companies that raise their dividend at a rate of 5% or more.

With the "Success Formula" in hand, I needed to come up with a way for it to support my long-term objectives.

My long-term objective is to grow the portfolio at an 8% compounded annual growth rate. I decided I would try to take advantage of total dividend return, current yield plus a 5 year CAGR to help support my long-term 8% CAGR objective. This total dividend return concept was dubbed The Chowder Rule by a Contributor on Seeking Alpha by the name of J.D. Welch.

More at the second link. Chowder has lowered his initial yield to 2.5%, but requires a higher 5 year dividend CAGR for those lower yielding stocks.

The Chowder rule number is the last point of consideration in the stock selection process. Companies that do not pass the earlier steps never get to the point of Chowder rule consideration

http://seekingalpha.com/instablog/728729...-selection

http://seekingalpha.com/instablog/728729...owder-rule
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#5
That's the guide to success in the DG strategy, but it's not a one time deal, but an ongoing one. Find your list of quality companies and buy them when they are value priced. That's how you get the High Yield and hopefully they continue with their history of high dividend growth to give you high total return. It's a waiting game.

If you are fortunate enough to have followed the strategy for some time, then your yield on investment should exceed the market returns and possibly with the dividends alone.
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#6
I use the chowder rule, along with fast graphs, for a quick valuation before I decide whether to do more research or not. It was never intended to be an endall metric from what Chowder says. Also if you have read the book The Single Best Investment by Lowell Miller, the Chowder rule is based on that. Chowder just applies his numbers to their principles.
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#7
"yield on investment"

I keep seeing this feel good term being used as if it has some relevance at what is the current 'future date'. IMO yield on investment has almost no relevance to anything. Perhaps if such is inflation adjusted, then it gives some idea as to how an incremental purchase succeeded over time. But for the portfolio as a whole, to me, yield on investment means nothing. All that really matters, is the yield as measured against the current portfolio value or for some, all that matters is the actual amount of cash flow that is generated at a particular time and how that cash flow varies over time.

I don't mind seeing the term used, but at least for me, the term always relegates the comment to a feel good comment rather than a substantive one.

I'm still of the opinion that one could simplify this whole process by asserting that [companies which have greater than market average rates of earnings growth will outperform the general market.] As posted earlier, I'm not convinced that dividend growth stocks will out perform any companies to which the first statement applies, but they should out perform dividend stocks in general, i.e. dividend stocks that don't have as much earnings growth to support dividend increases.

The fixation with dividends, to which I'm also guilty, could be counter productive in the sense that earnings growth, margin expansion, sales growth, moat, and other metrics may be far more important. As my income portfolio continues to get funded, I'll be considering these issues much more seriously.
Alex
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#8
Earnings growth is a metric used by chowder long before he gets to the chowder number. If a company does not pass that test, the chowder number does not get looked at.
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#9
(03-10-2014, 12:34 PM)hendi_alex Wrote: "yield on investment"

I keep seeing this feel good term being used as if it has some relevance at what is the current 'future date'. IMO yield on investment has almost no relevance to anything. Perhaps if such is inflation adjusted, then it gives some idea as to how an incremental purchase succeeded over time. But for the portfolio as a whole, to me, yield on investment means nothing. All that really matters, is the yield as measured against the current portfolio value or for some, all that matters is the actual amount of cash flow that is generated at a particular time and how that cash flow varies over time.

I don't mind seeing the term used, but at least for me, the term always relegates the comment to a feel good comment rather than a substantive one.

I'm still of the opinion that one could simplify this whole process by asserting that [companies which have greater than market average rates of earnings growth will outperform the general market.] As posted earlier, I'm not convinced that dividend growth stocks will out perform any companies to which the first statement applies, but they should out perform dividend stocks in general, i.e. dividend stocks that don't have as much earnings growth to support dividend increases.

The fixation with dividends, to which I'm also guilty, could be counter productive in the sense that earnings growth, margin expansion, sales growth, moat, and other metrics may be far more important. As my income portfolio continues to get funded, I'll be considering these issues much more seriously.

I understand why the term has little meaning to you as you are at retirement and relying on your stocks to produce income for you. It makes complete sense to put emphasis on current yield as that is what pays the bills.

I, on the other hand, am building a portfolio to hopefully retire on in 20 years. It matters greatly to me what my projected yield on cost for a prospective purchase is. I don't claim the chowder rule to be the end all answer on whether or not to purchase a stock, but it is a good tool to use.

I can reasonably assume, based on a 10-20 year history of consistent earnings and dividend growth along with analysts estimates for similar growth going forward, what a stock will produce in dividends alone 5 or 10 years from now. It makes it much easier to concentrate on the performance of the company over the fluctuations in share price.

If I can get a 10% yield on cost in 10 years I've already matched the returns of the S&P on dividend income alone. Any capital gains from increases in share price are just gravy on top of that.

I can control the structure of my portfolio for what dividends and to some extent dividend growth will be over the years. I can't control Mr. Market and what he's going to offer me in prices for what I hold.

I hope this makes some sense in explaining how I view DGI and the chowder rule.
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#10
The chowder rule appears to me to be an excellent metric for either initial screening or for determining the final cut. Dividend growth stocks represent great candidates in most anyone's portfolio, especially when in the early to mid accumulation phase. When nearing retirement, it would seem prudent to me, that an investors change the allocation to include more traditional income stocks (utilities, telecom, REITs, MLPs. etc.) and somewhat less DG or pure growth holdings. As posted earlier, my target in today's climate is to get an average current market yield of around 6%, which is what we are getting in our long term income portfolio. A 5% yield has been the cut off there, but once bought, the positions will be held as long as the company appears to execute well. I also want the holdings to give a reasonable shot a both dividend growth and at capital appreciation. For the foreseeable future, approximately 20% of our gross will be channeled into the dividend portfolio. Between dividend boosts, capital gains, and fresh capital, I would expect the portfolio to be well insulated from the effects of any likely level of inflation.

At some point we may include muni funds, preferred stock, and even CDs in the income account. The IRA will continue to be ear marked for more exotic investing such as covered call plays, short term trades, speculative buys, and pure options plays.
Alex
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#11
Where I've found the most use of the "chowder rule" is in narrowing down a list of stocks for further analysis.

For example, I was looking for a decent list of utilities to add to our portfolios. The last time I did this, I think the first cut through the CCC list ended up with about 15 companies to look at. Simply too many to research all of them and, of course, the CCC list doesn't include things like fuel mix, regulatory climate or geographic location. Then you have to factor in the capital projects in progress and non-regulated business results. So, to narrow my choices, I've used the chowder rule to knock down the research list to something reasonable.

To use it to compare different companies in disparate industries just doesn't make much sense to me. I've also noticed as I get closer to retirement, I'm starting to put more emphasis on current yield versus dividend growth. Eric's article he referenced (good article again, Eric!) pointed out the different outcomes where the chowder rule doesn't distinguish between yield and yield growth.

To the point of people using it as gospel, there are worse things they can use to select stocks in which to invest. If a company is on the CCC list and has a decent chowder rule number it will at least have a dividend and growth to it. It goes along with the myriad questions asked whether company xx is a good value at the time. Obviously, they do not understand or trust valuing companies for themselves nor whether it fits their needs or temperment. I worry about them being scared out of their investments the next time Mr. Market gets neurotic leading them to buy high and sell low.

All that to say I don't think it's detrimental to the naive investor but I use it to narrow a list of candidates within an industry for further research.
=====

“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan


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#12
(03-10-2014, 12:34 PM)hendi_alex Wrote: "yield on investment"

I keep seeing this feel good term being used as if it has some relevance at what is the current 'future date'. IMO yield on investment has almost no relevance to anything. Perhaps if such is inflation adjusted, then it gives some idea as to how an incremental purchase succeeded over time. But for the portfolio as a whole, to me, yield on investment means nothing. All that really matters, is the yield as measured against the current portfolio value or for some, all that matters is the actual amount of cash flow that is generated at a particular time and how that cash flow varies over time.

I don't mind seeing the term used, but at least for me, the term always relegates the comment to a feel good comment rather than a substantive one.

I'm still of the opinion that one could simplify this whole process by asserting that [companies which have greater than market average rates of earnings growth will outperform the general market.] As posted earlier, I'm not convinced that dividend growth stocks will out perform any companies to which the first statement applies, but they should out perform dividend stocks in general, i.e. dividend stocks that don't have as much earnings growth to support dividend increases.

The fixation with dividends, to which I'm also guilty, could be counter productive in the sense that earnings growth, margin expansion, sales growth, moat, and other metrics may be far more important. As my income portfolio continues to get funded, I'll be considering these issues much more seriously.

I seem to be the one flouting the phrase, because it's the measure I use to determine if my portfolio is generating the income I expect. If my total invested dollars is $100,000, which includes all purchases and re-invested dividends than I call that amount My Total Investment. When I look at what my portfolio is returning to me in Income that's my Yield on Investment.

If I'm getting $5,500 in dividends on the $100,000 than my Yield on Investment is 5.5%. If the market value of the portfolio is $155,000 today than the current yield may be 3.54%. But the dollar value for income is still $5,500. If the market crashes and the portfolio drops to $85,000 I don't worry as long as the dividends are not cut and I'm still getting $5,500 (or more if companies raise the dividend). I don't then say my yield is 6.47%.

Market value is of no concern to me unless I want to sell an investment, which I rarely do, (or add to the stocks I own). If I do buy or sell than my Total Investment will reflect the cost change.
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