The premise of dividend growth investing is not only to find a stock that can pay growing dividends, but also to add value to your portfolio over time.
Chowder, as identified on Seeking Alpha, defined this approach as double immersion. I really like the concept of double dipping and it has been the foundation of my stock selection approach.
That’s partly why I dropped the following blue chip stocks; Kimberley-Clark NYSE: KMB and Manulife TSE: MFC. You just didn’t pass the chowder score.
What makes the Chowder Rule perfect for my stock selection process is that it fits really well with my use of Dividend Achievers with 10% CAGR dividend growth over a 10 year period.
Another reason to like the rule is that it is inherently very easy for anyone to understand. All you have to do is add 2 numbers together and then make a decision based on your investment goals.
What is the chowder rule?
The Chowder Rule simply attempts to identify a high-growth dividend stock by adding up the current dividend yield and 5-year CAGR dividend growth.
The rule is set up to produce the best total return dividend stock that makes money off dividend growth and stock appreciation.
High Quality Stocks + High Current Yield + High Yield Growth = High Total Return.
It’s that simple and embodies the following two stock investment concepts. He created the rule to help him decide between buying a great company with a dividend yield of 1% or some other great stock with a dividend yield of 5% and all other returns in between.
There is a desire to receive dividend income, but not at the expense of total return (dividend income vs. total return). The rule helps pull the two together and uses CAGR dividend growth to help establish a company’s growth.
Calculation of the chowder score
Through the numbers, the formula takes the following form for me.
Current yield + min (3/5/10) dividend growth per year = total yield.
The simplest formula is the following.
Current yield + 5 year dividend growth = total yield.
Your access to data determines what you can calculate, but I prefer the first after evaluating 3, 5, or 10 year dividend growth across 100+ companies. The min approach provides a worst-case model that prevents us from overestimating future total returns.
Dividend yield reflects market price of investors
The rule takes into account the fact that if a stock is doing well and is valued by investors, the dividend yield would remain relative and within a certain range. If the stock were overvalued, the dividend yield would go up when the price went down, and if it were undervalued, the price would tend to go up and the dividend yield would go down. This is how the stock market reacts to the performance of a company.
Dividend growth reflects the company’s profitability
When you use the company’s historical dividend growth to determine the company’s earnings, you can assume that constant dividend growth implies that the company is able to grow its earnings and increase profits. You can’t consistently increase the dividend without the stock’s price (see previous point) stalling.
One caveat to dividend growth is to make sure that the dividend payout ratio doesn’t grow at the same rate, otherwise it is false growth in the bottom line.
Applying the Chowder Rule
Chowder made the following guidelines for yourself, but you should tailor them to suit your investment style. His initial considerations, based on his research, were a 3% dividend yield and 5% dividend growth for a total of 8%. He then adjusted it for the trench and settled for a total of 12%.
- For a stock with a 3% dividend yield, he needs 9% dividend growth. This is where dividend yield and dividend growth can balance each other out.
- For certain stocks such as utilities, he sets the standard target of lower dividend growth of 5%, for a total of 8%
How do I use the chowder rule
After applying the Chowder Rule to my dividend stock list (all over 150 stocks), I was no longer as happy with the results of Chowder’s 5-year dividend growth rate. Some stocks have passed the rule without the persistence of dividend growth.
I tried 10 years old and got the same results, as well as average dividend growth of 3, 5, and 10 years. I decided to use the lowest of the 3 data points I’m tracking and that worked fine.
The result of using the minimum value of 3, 5, or 10 year CAGR dividend growth is that it eliminates any inconsistent spike in dividend growth and is a little stricter.
I intend to amalgamate my stock selection process by using the chowder rule for dividend achievers together. Remember, the rule doesn’t rate whether a stock is undervalued or not, or whether it’s a good company to invest in first.
The High quality warehouse Part is for you to judge as the Chowder Rule attempts to determine the potential for overall growth based on historical trends.