The Dividend Guy Investment Process Part 7: Fundamental Analysis: Debt, ROE, and Payout Ratio

In the last post I started to discuss my approach to dividend investment analysis. The first place I look is revenue, and more importantly earnings per share. The next things I look at during my analysis include a number of ratios, return on equity, and dividend growth. I will present the format I use on this blog to highlight the areas I look at when analyzing stocks.

Return on Equity

Return on equity is a measure of how well management of the company is using the equity in the company to deliver a return for shareholders. My view is that shareholders should expect a minimum ROE of 15%. However, more importantly is the consistency of this ROE over a number of years. I would much prefer to see a steady and consistent ROE number year after year. That is why I look at the last 5 years of ROE data and graph it to get a visualization of the ROE trend and numbers. Below is a graph that shows Disney’s ROE and the scoring chart I use to record how well the company has done. You will see that Disney did not score well on this as they did not achieve those consistent results I look for.

Click to Enlarge

Other Ratios

There are a number of other ratios I look at to gauge how good of an investment a company will be. The following chart show what ratios these are and the criteria and scoring system I use:

A company either passes or fails when it comes to these ratios. I view all of these ratios as very important to the ability of a company to operate profitably. For example, like in our own personal finances, too much debt can have very negative effects on a company’s ability to operate. Same with the payout ratio – if a company is paying out too much money in dividends and the payout ratio is too high that indicates the company may not be able to sustain the high dividend payments.

I get this information from a couple of sources: Morningstar, MSN, Yahoo!, and Globeinvestor.

Annual Dividends

As you know, dividends are the crux of my equity portion of my portfolio. For each company I purchase, I look at the historical dividend payments to see what the trend has been. The chart and table below present the results of this type of analysis:

Click to Enlarge

The chart is pretty self-explanatory. I look for the line going up and going up steeply and obtain the data from the CSA software I use. I score dividend growth based on the number of years the company has increased their dividends. The company gets one point for having 10+ years of dividend growth (i.e. are Dividend Achievers), and they get another point for having 25+ years (S&P Dividend Aristocrats).

I don’t want to make it look like I over-simplify the analysis of stocks by simply scoring them. As I look at items such as revenue, EPS, ROE, and the ratios I am delving in for more information if something does not seem to fit. This means going through annual reports and news releases to ensure I understand what is going on with the company. I am presenting the framework and process I go through, and not suggesting that this is all it takes to analyze a company. My point is that I have a process and framework to guide my analysis, and these process posts present that.

If all the factors discussed in the past 2 posts are looking good, then it is time to spend some time seeing if the company is worth buying at the share price it is trading at. That is the topic of the next post – valuation.