Welcome to another monthly dividend stock pick post! Here I will explain my screening process for finding high-quality dividend stocks. I will highlight which stocks are currently in my portfolio as well as my favorite picks this month that I will be looking to add. Please keep in mind, all suggestions or chart interpretations are all my opinion, I always highly advise you do your own research and make sure you understand a company before you invest in it. Now let’s review last month’s picks (if you’re not interested in the breakdown of the screener than feel free to scroll down to this month’s picks)!
Now let’s dive into the stock screening criteria and our picks for this month!
Stock Screening Criteria
My stock screening criteria contains a mix of hard stats combined with a few fundamental ratios that I use as rules of thumb in order to identify stocks that reliably pay increasing dividends while also identifying if the stocks are undervalued and poised for growth.
My criteria gave me a list of 16 stocks which I narrowed down to 3. As Warren Buffett once said, “Never invest in a company you don’t understand.” I adhere to this rule and take stocks out of my watchlist based on my comfortability with understanding the company and the attractiveness of their chart. Below are the criteria and why I use them.
Market Capitalization, also called market cap, shows us how much a company is worth as determined by the stock market. A company’s market cap is equal to the total value of a company’s outstanding shares of stock. For example, if a company has a total of 1 million shares selling for $10 each, that company’s market cap would be 10 million.
I screen for companies with a market cap of at least 10 billion. These are generally called large-cap companies. These companies are large, established, are the most common stocks to pay dividends, and are not generally at risk of going under any time soon. For a dividend portfolio, large cap stocks will be our bread and butter. These companies do not usually bring in huge gains in the short term, but in the long term they generally trend upward with consistent increases in share value and dividend payments, which is the name of game with a dividend portfolio.
I will do some experimenting with smaller companies; however, these monthly stock picks will be the majority of my portfolio and thus I will stick to screening for companies with a market cap of at least 10 billion.
The dividend yield is a financial ratio which shows how much a company pays out in dividends each year in relation to its stock price (annual dividends per share/price per share). For example, if a stock pays $5 per year and has a market price of $100, the dividend yield would be 5%.
As a dividend investor, you would think that the higher the yield the better because we want to maximize dividends. While that logic is correct, it is important to understand why certain stocks may have uncommonly high dividend yields. If a company has healthy finances, a high dividend yield may mean that the company is unnecessarily shelling out lots of money in the forms of dividends when it could be utilizing some of those funds instead to better position the company for long term success. Every dollar a company pays out as a dividend is a dollar the company is not using to generate capital gains. We want to see a healthy balance of dividends and capital growth and sometimes a high dividend yield indicates the opposite.
A high dividend yield could also mean the stock’s price is declining while the dividend payout remains the same. The stock’s price is the denominator in the equation, so if the stock is trending downwards and the dividend payout remains the same, it will inflate the yield. Take for example a stock that paid a $1 dollar dividend per share last year with a cost of $20 dollars per share. That results in a 5% dividend yield. Imagine this year that same stock still paid $1 but now the stock was worth $10. The dividend yield would now be 10%, which is an increase from last year at the expense of the stock going down 50%.
In summary, a high dividend yield is not always bad, it just calls to our attention that we should review other metrics of the stock to confirm that the company is healthy. With all those things in mind, I screen with a dividend yield of greater than 3%. The average dividend yield of the S&P 500 is 2.22%. This screen keeps us higher than that average and higher than inflation while also not being too high that we must worry about unhealthy dividend yields. We still may see some suspiciously high yields in our list, this just means we will dive into those stocks in more depth to understand why.
Consecutive Years of Dividend Growth
This criterion is straight forward. Past performance isn’t always a great indicator of future performance, but in the case of dividends I don’t think this mindset is overly risky. If a dividend has increased year over year for a substantial amount of time, it is fair to expect that it will continue to do so. That is why I screen for stocks that have grown their dividends consecutively for at least 7 years. Lots of companies pride themselves on attaining the status of a “Dividend King” or a “Dividend Aristocrat” as it is quite the impressive title and it attracts dividend investors which is good for the stock’s price in the long term. By screening for at least 7 years of consecutive increases we may be able to find companies that are on their way to attaining those titles and we can benefit from their efforts to do so.
This criterion I use as a rule of thumb and not a hard stat. P/E ratio is the price-to-earnings ratio and is calculated by market value per share divided by earnings per share. This ratio is commonly used by investors and analysts to determine if a stock is relatively undervalued and overvalued. This is where Warren Buffett found lots of success, he was great at finding companies that had discounted stock prices.
There are many complex methodologies that one can use to determine a stock’s relative value, however I believe the P/E ratio is the quickest and most straightforward way to understand a stock’s relative value. Generally, a high P/E ratio means that a stock is overvalued, and a low ratio means it is undervalued.
Seems simple enough, but there are a few limitations to keep in mind. With earnings per share as the denominator, if a stock has a very small earnings per share or none at all the P/E ratio won’t give you a true understanding of the stock’s relative value. P/E ratios also vary greatly from industry to industry. Therefore, it is helpful to view a stocks P/E ratio year over year to see how it is trending relative to stock price. It is also helpful to understand the P/E ratio of the market or the industry a certain stock is in. This information can give you context clues to determine if a stocks P/E ratio is healthy or not.
The S&P 500 has averaged a P/E ratio of 15.95 since its inception. With the above information in mind, I like to look for P/E ratios that range from 15-30, but sometimes exceptions will be made for stocks that require further research.
The debt-to-equity ratio compares a company’s total liabilities to its shareholder equity which lets us know how much leverage they are using. It measures how much debt versus equity they are using to finance their operations. In general, a high D/E ratio means higher leverage which means the company is aggressively financing its growth with debt which is risky.
If a lot of debt is used to finance the business, the cost of that debt could outweigh the benefits of the increase in earnings that it produces, however the opposite can also be true in some cases. Cost of debt can vary with market conditions and D/E ratios can vary greatly depending on industry, so it’s not always clear if a company is over leveraged or not.
In general, a high D/E ratio usually means more risk, especially to stocks that pay dividends. If a company is needing to pay down its debts, it has less cash on hand to pay dividends. My general rule of thumb for D/E trailing 12 month average is less than 15. Best case scenario, the D/E is less than 2, but some stocks will be in industries that are capital intensive which generally require more debt, so I will not immediately remove a stock from this list if they have a high D/E, these stocks will just require further research.
Above is a table of the stocks, their data that meets my screening criteria, plus some other information that is beneficial for evaluating dividend strength and good times to buy. Next, we will look at each stock, go over a little bit about the company, and discuss their chart.
Chevron started in 1879 through the discovery of an oil field near Los Angeles that produced 25 barrels of oil per day. Now, Chevron is one of the largest oil companies in the world and produces over 3 million barrels of oil or oil-equivalent materials each day. Chevron makes most of its profits by exploring for and producing oil, gas, and liquefied natural gas, but they also own refineries that use crude oil to make petroleum products. Despite operating in a highly cyclical industry, Chevron has managed to pay uninterrupted dividends since 1912 through adept management of costs and smart capital allocation decisions. Chevron acquires rivals during downturns and continuously reinvests profits into more exploration and production. Through these activities, Chevron has achieved huge scale which gives them a lasting advantage over competition. Chevron’s diverse asset base (heavy oil, deepwater, natural gas, conventional oil, shale, and their vast network of vertical integrated refineries) helps them to optimize profitability across a diverse portfolio of resources without sacrificing financial flexibility. The only concerning thing I saw about Chevron was their high payout ratio, however, given their extremely low leverage, that is a pretty mute issue.
Chevron’s chart looks promising. Within the last month, CVX price pushed through $113 resistance area that it failed to break twice this year. However, it hasn’t broken through that level with strength, and I am not certain that the resistance level has now turned into a support level. I will keep watching around the $113 area, if it breaks down again, we may see some great buying opportunities, if it holds support we could see upside to roughly the $120 price area that we saw in 2019.
J. M. Smucker (SJM)
J.M. Smucker’s was founded in 1897 when its founder began selling apple butter from his horse-drawn wagon (I freakin’ love apple butter). Since then, the company has grown to being one of the leading vendors of consumer-packaged goods found in most U.S. homes. The company’s portfolio of well-known products is balanced across at-home coffee (Folgers, Dunkin’), pet foods (Nutrish, Milk-Bone), and consumer foods (Smucker’s jams, Jif). Smucker’s industry has several strong barriers to entry including brand recognition, huge advertising budgets, retailer relationships, economies of scale, and the finances to be able to adapt to changes in consumer taste. Smucker’s size and recognizability allows them to outspend and outperform smaller rivals which has allowed them to obtain solid profit margins over the years. Their high cost of building Smucker’s brands’ awareness drives their growth and keeps new food producers from creeping into their territory. Smucker’s business has a strong moat which should allow them to continue to generate healthy cash flows and support their dividend which has been paid every year since 1972 and increased every year since 2002. Their products are recession resistant and the company is built to last for the foreseeable future.
SJM looks like a primed cup and handle pattern. The handle has formed at a depth of about ½ of the depth of the cup and has closed higher for the 3 days following that bottom. If we can see the handle break above the edge of the cup around the $130 area, we can see this pattern play out with upside to the highs of the year to date around the $140 area. However, given the state of the market, a failed pattern may be more realistic, and we could see prices come down to support at the $122 area. If it breaks down, I’ll watch and wait for downward pressure before adding. If we see the pattern play out, I will add shares as it breaks the upper line of the handle.
Lockheed Martin (LMT)
Lockheed Martin is a repeat watchlist pick from last month. They are the world’s largest defense contractor and supplier of fight aircraft. Lockheed’s business spans various combat aircraft, missile defense systems, military helicopter, and satellite systems, though they are best known for their F-35 fighter. A majority of their business is with the US government, which is trust that is hard to win. Few, if any, other companies have as much experience and capacity as Lockheed to win and deliver decade-long defense contracts that earns the trust of the world’s most powerful governments. Lockheed invests heavily each year into research and development to keep them on the cutting edge of technology that other smaller rivals can’t match. Much of Lockheed’s R&D is partly funded by government entities which makes their integrated relationships even more difficult to disrupt. Barriers to entry has caused the defense industry to consolidate over the years which limits the number of competitors that Lockheed has to bid against. This keeps Lockheed’s backlog full and in many ways puts them in a position where they are too big and too important to fail, regardless of political and social opinions on defense spending.
LMT is practically at the same level that it was at a month ago for the last stock pick. LMT bounced and established a bottom around the $330-$325 area. This month, the play is essentially the same. We can bounce and see upside to the upper $340 area or it could break support and head towards 52 week lows at $320. I think the upside is more likely now that we have a tried and true support area from last month. In my opinion, it is a good time to add as I think the strength of the bounce is evident depending on the direction of the market these next few weeks.
In this article, I screened for stocks that look like they will provide regular growing dividends while also having potential for capital gains. My screening criteria found 16 stocks which fit the mold, I then narrowed that list down to 3 based off of the attractiveness of the stock’s chart and my comfort with understanding the company.
I am long on all the stocks on this list. Of the picks, I already have a position in LMT. I will watch this list play out through the month and will either open new positions or add to current positions at key levels if my capital allows.
I do also take into account what months these stocks pay their dividends and I try to balance my portfolio so that I am earning roughly the same amount of dividends every month. This goal may influence my timing and decisioning when it comes to purchasing some of the stocks on this list.
All 3 stocks are suitable for further research and my article is not to be taken as financial advice. Thank you for reading and feel free to leave any replies or questions you may have on here or on my socials.