Today’s post was sent in from Bryan over at IncomeSurfer.com.

Hello!  I am Bryan, the founder of IncomeSurfer.com.  On Income Surfer you will read about techniques and strategies to live a fulfilling and balanced life, both financially and relationally.  I offer a monthly newsletter that includes changes in my family’s portfolio, assets we are looking at buying/selling, and interesting articles that give a historical perspective to the capital markets.  You will also read articles about my family’s quest for balance, our travels, and how we have changed our lives to be more fulfilling.  My business partner and I currently have three outstanding valuation tools under development.  Income Surfer is also on Twitter, @IncomeSurf.

In my opinion, finding a great investment is much more science than art.  I do go through a thought process when searching for a great investment as I detailed in an article last week, but it’s primarily about the metrics once I’ve zeroed in on a specific sector.  Below I discuss some of those metrics.

The Metrics

The specific metrics depend on the type of investment I’m looking for…….is it a small unloved and undervalued business I will own for a few months……. or a steady long term dividend grower I will own for decades?  I will focus on long term dividend growing companies today, because you are readers of Dividend Ladder.  Truth be told, almost all of my investments over the past few years have been in dividend growth stocks.  Once global stock markets surged back from the 2008-2009 financial crisis, unloved and undervalued stocks became much tougher to find.  Fortunately, there have been plenty of long term dividend growth stocks available for purchase.  With that in mind, below are some of the key metrics I use to evaluate long term investments.

  1. Return on Equity(ROE)-  I like to see a consistently high return on equity for my long term holdings.  If you need examples, look at Coca-Cola (KO) or Aflac (AFL).  Keep in mind that when I say “consistently high”, I mean with regard to the particular sector in which the company operates.
  2. Dividend Growth History-  I like to see a long term record of steadily rising dividend payments.  I also look to see that the earnings per share and free cash flow per share are growing as quickly as the dividend payments, on average.  Be sure to look at the dividend payments in their native currency, as currency conversions can cause fluctuations.
  3. “Reasonable” Dividend Payout Ratio-  Again, the definition of “reasonable” varies by industry. On the whole, I want to see a dividend payout ratio that isn’t rising very quickly.  Also I am not comfortable investing in companies where the dividend payout ratio is above 75%, or 85% for utility companies.
  4. Trend of Operating Cash Flow and Operating Margins-  I want to see steady or improving margins and operating cash flows.  As a whole, corporate margins are at all time highs currently.  I believe in mean reversion, therefore future profitability will likely be somewhat squeezed for most companies.
  5. Net Stock Issuance-  I am wary of investing in a company that consistently issues new stock, which of course dilutes my ownership position.  If you pay attention to this metric, I think you’ll be surprised which companies are guilty of watering down your ownership stake.

 

Dividendladder.com has done a great job of rolling several important metrics into a single metric.  With the Historical Performance Rating (HPR), they have given their members another way to analyze and screen for stocks.  HPR is based on a given stock’s: dividend yield, free cash flow yield, dividend growth, income growth, payout ratio, and 12 month return.

 

“Growth and value are joined at the hip” ~ Warren Buffett

 

Conclusion

With careful research and the help of great investment tools, you can record solid returns over the long term.  I hope you have enjoyed my thoughts on the metrics I use most.  Clearly, different types of investors use different metrics when valuing potential investments.  The metrics listed above have served me well over the past 17 years.  Great values have become harder to find in the current market.  I have been updating my watch list and letting the cash build in my portfolio.  Another great opportunity is right around the corner, we just need to be ready to seize it.  If you are interested in getting a look at specific stocks on my watch list, be sure and sign up for my free monthly newsletter.

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