Friday, May 14, 2010

What Is Intrinsic Value? – Reliable Long Term Dividends

My definition of intrinsic value boils down to “a wonderful company fairly valued”. By judging 14 value elements I’ll determine if a company deserves this description. It’s my intention to select and buy stocks based on their intrinsic value and to thereby get rich slowly; rich enough, at least, to fund my retirement.

14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long Term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually

(12) Reliable Long Term Dividend Income Stream
This is the third value element focused on dividends. Obviously dividends are important to me, but how is a “Reliable Long Term Dividend Income Stream” different from (3) Dividend Consistency and (4) Consistent Dividend Increases?

Well, value elements (3) and (4) look at history. Element (12) wants to look into the future. Since I have no crystal ball I can only guess at the future but I’ll make the guess as educated as I can.

Scoring well on value elements (3) & (4) is a baseline. If dividends were inconsistent in the past, I can’t expect the future dividend stream to be better. However, when I measure dividend growth I record the dividends paid five years ago and the current annualized payout. I see, but I don’t record, the intervening three years.

When I look at the five annual payout figures I can easily evaluate the series looking for years without dividend increases, years with dividend cuts, and years with zero dividend payments as well as consistent annual increases. In my analysis, I’ll reward companies that increase dividends every year and progressively punish them for years without increases and for years without payments.

I’m already rewarding companies for being listed in the Dividend Achievers and the Dividend Aristocrats indexes so I won’t consider those measures further.

(11) Measure Risk includes measurements of an earnings based dividend payout ratio (Div/EPS) and a cash flow based payout ratio (CF/Div). These risk measurements are predictors of a company’s ability to pay future dividends.

Another predictor is the consistency of a company’s earnings. In calculating value element (2) Strong Earnings Growth I look at five years of net income. As in the value element (4) I only use the net income from the most recent year and from five years ago.

However, I can also look at the three intervening years and record year over year drops in net income and especially losses. I'll reward companies with consistently increasing net income and punish them progressively for years when income falls and for losses.

“Predictions are hard, especially about the future;” As Yogi Berra said. But, using these criteria I hope to select investments that provide a reliable long term dividend income stream. The remaining risk to my dividend stream I’ll mitigate by maintaining a diversified portfolio of dividend payers.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

No comments:

Post a Comment