This is the 4th installment about our project to build a general-purpose dividend growth “ETF” at Motif Investing. I hope to launch the new portfolio on January 1.
If you need to catch up, please see these previous articles about this project:
• We’re Building a Dividend Growth “ETF” that Anyone Can Invest In! (November 7, 2016)
• Our Dividend Growth “ETF”: Business Plan (November 12, 2016)
• Picking Stocks for Our Dividend Growth “ETF” (November 16, 2016)
In this article, I will discuss how I am whittling the 750 or so initial candidates down to the eventual 25-30 that will be in the portfolio when we kick it off on January 1.
Picking Up the Story
In the previous articles, I described:
• How we started with more than 750 candidates on the Dividend Champions, Contenders, and Challengers list. They all have dividend increase streaks of 5 years or more.
• How I used a variety of existing sources – including my own Dividend Growth Stocks of the Month – to identify 200 or so of the best candidates from the 750.
• The scoring system that I am using to cull the lists further. The system examines, among other factors:
o Yield. I want the portfolio to have an overall yield of about 3.5%, although the yields of individual stocks will vary from 1% upwards.
o 5-year dividend growth rate. I want the overall portfolio to project an annual DGR of 6% or more.
o Dividend Safety Grades from Simply Safe Dividends.
o Credit ratings from S&P.
o Financial statistics and projections such as return on equity (ROE), earnings growth rates, and debt levels.
The idea is to use the scoring system to identify the best companies. My goal is to get the candidates down to 40 or so finalists. Then I will employ valuation analysis to identify the best buys currently.
Ultimately, the motif portfolio will contain between 25-30 stocks.
The previous article identified >20 companies that were eliminated right off the bat for not meeting minimum requirements, such as having dividend increase streaks of <5 years or yields <1%. That’s where we pick up the story.
Sorting Down the Candidates
Since the last article, I have sorted through the candidates in the following ways:
• By yield: I wanted to see how many of the remaining stocks had yields of 4%+, 3-4%, and so on. So I created buckets based on yield ranges. Most of the stocks fell into the middle ranges (2%-3% yields). There were fewer companies in the lowest (1%-1.9%) and highest (4%+) ranges.
• By score: Using the scoring system on the preliminary data collected before the election, I sorted all the stocks by their score. My experience with scoring systems is that, even if your data is incomplete, many stocks can be identified fairly early, because it becomes apparent that they have no chance of making it to the final round. They can be eliminated in preliminary rounds to save unnecessary work later.
• By Morningstar valuation. While Morningstar is just 1 of 4 methods that I will use for final valuation, it was easy to pick up their stars and sort on that value (1-5). I wanted to see if there were likely to be decent values available when it comes to final selection. The answer is yes, even though the market has run up since the election.
I started with the buckets of stocks sorted by yield. I took the top-scoring candidates from each of the yield ranges, because I want to have a diversity of yields in the final portfolio. To be specific, I took the top:
• 12 stocks from the 4.0%+ category
• 20 stocks from 3.0%-3.9%
• 20 stocks from 2.0%-2.9%
• 12 stocks from 1.0%-1.9%
I recombined those into a single table of 64 stocks. Then I subjected them to 2 other sortings (by preliminary score and yield). Then I took the top 20 stocks from each sort and eliminated duplicates. That gave me 32 stocks to advance to the next stage.
Rather, I re-examined each one individually.
Based on my experience and general knowledge of the field, I identified 24 that I did not feel comfortable throwing out based on the preliminary data.
I want to give them another chance after all the data is updated and re-scored.
So I added those names back to the 32 described above.
That also reduces the impact of unintended bias that may have crept in based on the parameters I used for sorting.
32 + 24 = 56 semi-finalists. Here they are. Since this is a copy of a working file, some of the data has already been updated post-election, but not all of it. That is also why there are some white cells (unscored data) and missing data.
Preliminary scores in the “Total Score” column have been zeroed out, because they will change when all the data has been updated and re-scored.
Please excuse those vagaries in the presentation. The purpose here is to show you the 56 stocks that have made it to the semi-final stage. They are sorted alphabetically by ticker.
More Stocks Eliminated
The following prominent names are among the stocks that were eliminated by the exercises just described.
All of these stocks had preliminary scores in the low 50s or 40s. While scores are not absolute determiners at this stage, some scores were low enough in their yield categories that I know now that they would not make it into the final portfolio. It saves work to eliminate them at this point.
A few companies were eliminated for other reasons. Wells Fargo (WFC), for example, has been in the news lately for scandalous sales practices. Despite the fact that Morningstar still maintains an “Exemplary” Stewardship rating on Wells Fargo, this is the kind of bad-news call that you can make on your own.
The next stage is to complete updating the data for all of the 56 semi-finalists. I will also keep my eye out for any stock that ought to be added to the candidates based on recent developments or suggestions from readers.
After all the data has been updated, I will re-score every stock.
Then I intend to eliminate about 16 stocks to arrive at the finalists. Those eliminations will largely be based on scores, although I will also be watching for diversity across yields, DGRs, and economic sectors.
The outcome will be that there will be about 40 finalists competing for the 25-30 positions that will make it into the “ETF” portfolio.
I will apply my valuation process to those finalists.
Finally, near the end of the month, I will select the actual stocks for the portfolio. As just described, I will rely heavily, but not exclusively, on the scores.
Valuations will also play an important role. Ties between similar-scoring stocks may be broken based on valuation.
I may allow a couple of overvalued but outstanding companies into the portfolio. Normally I would not do that, but since this is a fake ETF, it has to be ready all at once. That said, I intend to leave a few slots open for the later addition of excellent companies that may slide into better valuation than they have now.
Next time, I will present the 40 finalists, with updated data and scores for each one.
As always, I would love to hear your ideas. If you want to give me some input, please email the editors at DailyTradeAlert. Let them know your thoughts, and they will pass them along to me. I promise to take all views into consideration as we move to our final selections.
– Dave Van Knapp
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