This is a guest post by Jeremy J. McNeil. Many of you may remember Jeremy as the original Dividend Guy. He was also one of the founding members of DIV-Net. In this article Jeremy will share his new approach on selecting stocks.
Introduction
As a dividend investor, I used to buy dividend stocks with very little consideration of price. The thinking was that a good dividend growth stock was always going to rise in price over the long term.
Overall that may be true, but given the recent turmoil in the markets as well as considering what we went through in 2008 I started to give that more thought. I saw weaker holding really get slammed in price. With that learning in place, I started to ask if I should be buying dividend stocks without any consideration of price?
Over time I determined that there was a better way for me to judge which dividend stocks to get into. The method I now use is a trend following system. In this article, I will explain that process in detail.
What is Trend Following?
Trend following in equities is a systematic investing approach where stocks are bought based on the sustained price movement of that stock.
This is not about trying to predict the future - that is impossible. Instead when an investor uses trend following they are using tools to determine what the direction the price is moving over a period of time.
A stock can only do one of three things: move up, move down, or move sideways.
A very important concept in trend following is the issue of time. There are trend followers out there who trade trends based on minutes or hours. On the other end of the spectrum are trend followers who invest based on trends established with years of data.
For dividend investors, the trends that are occurring over years of time is what is important to us. We are not day traders or even swing traders. We are long-term investors looking to build up our income streams with dividend growth stocks.
As investors, I would argue that we are all looking for our stock prices to move higher. A “simple” way to do that is to buy stocks that are in a long term uptrend. When coupled with a dividend based strategy, the results can be very positive.
Before I talk about how to incorporate trend following into your investing process, I want to quickly cover how to select the best dividend stocks.
What Are Good Dividend Stocks?
My own personal style of investing has evolved into a very systematic way to buy and sell stocks which uses very little fundamental analysis.
However, most dividend investors want to be able to identify the best dividend stocks. If that is you, then there is nothing wrong with looking for those amazing dividend growth stocks, and then applying trend following principles to select the best of the best.
So, how do you start off and decide which dividend stocks to consider? The good thing is that work has been done for you by D4L and work he has done on his site. His post, A Winning Investment Strategy, he covers the crucial elements of solid dividend stocks.
Here is a summary of the things he looks for in quality dividend stocks:
Long History Of Consecutive Dividend Increases
This one is obvious, as dividend investors we want to see a long history of rising dividends to continually grow our income.
Strong Free Cash Flow
Dividends are paid with cash, so a company must have the free cash flow available to pay out those dividends. Good dividend stocks have solid free cash flow.
Low Debt To Total Capital Invested
High debt = huge cash flow constraints. Quality dividend stocks carry lower levels of debt which frees up cash to pay out dividends.
Excellent Dividend Fundamentals
The dividend income must be able to perform better for you than socking your money into a bond or other fixed income vehicle. As an equity investor you are taking on risk so you better get rewarded for that.
Trading At A Fair Value
This is paying the right price for the stock; not overpaying based on all the other factors.
Number five is where I believe that trend following fits in nicely. Once you have a solid dividend stock, then looking at the price history of that stock to see what it has done can be very helpful in your decision.
If it has been moving higher over periods of years, then chances are you have a good investment in front of you.
So how do you identify whether a stock is in a solid uptrend? It is not very difficult to do, yet it is something that very few investors actually do.
How to Identify Trend Following Stocks
The trend following system I use on my site is slightly more complicated than what I am going to cover here. I use regression analysis and slope to identify trends and then a series of buy and sell rules that moves me into stocks that are trending very strongly. At times I may look at the list of top ranked stocks and weed out the super-strong dividend payers. The performance has been very strong.
However, for dividend investors who simply want to find dividend stocks that are trending higher, the process does not need to be that complicated if all you are after is growing income with a greater chance of share price appreciation.
Here are two methods to consider; the first starts with your own list of dividend stocks and then determining the trend. The second method uses a screening tool to identify a list of stocks which you can then run your dividend analysis on.
Method 1:
If you already have a list of dividend stocks and want to simply select the ones with the best price action, then all it takes is a chart with a couple of things set up.
My favorite free charting tool online is TradingView. All you need to do as a dividend investor is take your list of dividend growth stocks and enter them into the chart, click on the 5 year timeframe in the bottom left of the chart and you will get a good indication of the chart.
If you want to get a bit more specific, add the 200 day simple moving average to the chart. By adding in this line you will get a real good view of what the trend has been on the stock.
Here is a good example of what I am talking about. In a recent post, D4L talked about Assurant Inc. (NYSE:AIZ) and its 67% increase in quarterly dividends. In fact this is a stock my system has identified as a recent buy. Here is the chart for that stock:
As you can see, AIZ has had a solid uptrend since September 2013. There has been some flattening of that trend but there is no denying it has been heading higher over the years. If you look at the 200 day moving average, that line is moving higher.
Although trend followers do not predict the future, we rely on the strength of this trend to guide our decisions. Based on the above chart AIZ could be a strong contender as a dividend stock to consider given that strong move up going back years.
I want to show you an example of a dividend stock that does not have the trend I am looking for. In that same article mentioned above, Brady Corporation (NYSE:BRC) has had dividend growth. Not as high as AIZ but dividend growth none-the-less. Here is that company’s 5-year chart:
As you can clearly see, this stock is in a huge downtrend. Dividend growth aside, it certainly would not be a fun stock to hold as you lost over $15 per share since 2013. Also note the 200 day moving average line; it is moving down indicating that the overall trend is down.
Of these two example, I personally would be much more comfortable holding AIZ which is trending higher.
It may go against the buy low sell high philosophy, however with a stock like BRC an investor would be riding a trend down and the buy low sell lower may be in the cards.
Method 2:
What if you don’t have a list of dividend stocks readily available, but still want to identify stocks that are in a solid uptrend?
Our objective here is to look for stocks that are in a multiple year uptrend and then run our dividend analysis on them. The difference between this method and method #1 is that you don’t already have a list of stocks you want to consider. This method will help you identify that list as a starting point.
This method can be done with another free tool available on the web. Finviz is an amazing site with a lot of useful features, but most importantly the free screener that have.
To identify a list of eligible stocks in a defined uptrend, you simply click on the screener link and select the options as I have selected below.
The primary selections which will give you the trend of the stock are the Performance and the 200-Day Simple Moving Average. I also selected the 50 day moving average in this example, but you can play around with that.
To get dividend stocks, I simply had the screen look for stocks with a dividend yield greater than 2%. I really wish there was an option for dividend growth rates; maybe if we all suggest that to FINVIZ they would put that in!
Once your selections are made, you will be presented with a list of stocks that meet those criteria. On the day I ran it, I was left with 32 stocks. If I wanted to get less, I would simply need to get tighter on my criteria to whittle the list down. For example, by adding a debt/equity < 1, the list dropped down to 13 stocks.
The next step is to take your list of stocks and apply your method for determining good dividend stocks from this list. As a good start, you can use the criteria we talked about above from D4L and filter the stocks with the best dividend growth rates.
Using either Method #1 or Method #2 are great ways to start adding in a trend following methodology into your own investment strategy. I encourage you to give it a try.
Three Examples of Dividend Growth Stocks with Long-Term Trends
As I mentioned earlier, I have a systematic investing system that I use to identify long-term trending stocks. This system primarily uses regression analysis and slope to identify trends, and then buys and sells based on market direction and proper position sizing. It is a mechanical approach that has worked well.
Here are three stocks that have recently increased their dividends and are involved in a really strong uptrend that my system identified as buys recently.
Royal Caribbean Cruises Ltd. is a Norwegian and American global cruise company that owns and operates cruise ships under the following trade names: Royal Caribbean International, Celebrity Cruises, Azamara Club Cruises, Pullmantur Cruises, and CDF Croisières de France, plus has a 50% stake in TUI Cruises. The company has increased its quarterly dividend 25% to $0.375 per share. Add that to a share price growth profile as shown in the chart below and you can see a solid potential investment.
TWC is an American cable telecommunications company. Despite the various takeover challenges and the most recent acquisition announcement by Charter Communications (NASDAQ:CHTR), the company has continued to increase its dividend and see solid share price appreciation. The company's 3-Year Dividends Growth Rate is 16.00% as of June 2015 and a nice gain in share price going back to 2009. Nice return for dividend focused investors.
ConAgra is a packaged foods company that sells a number of products under in the Consumer Foods, Commercial Foods, and Private Brands space. Some of the well known brands the company operates include Chef Boyardee, Egg Beaters, Healthy Choice, Hunt’s, Orville Redenbacher’s, PAM, Reddi-wip, and Slim Jim. ConAgra has been a solid dividend grower and has a five-year dividend growth rate of 4.60%. Here is the price chart which shows the share price appreciation over the past six years.
Summary
I hope that I have shed some light on what trend following with equities is all about and how you can use it in your own dividend based portfolios.
My suggestion is to not simply buy because of good stock fundamentals and a growing dividend. Instead, consider the long term trend of the stock and when comparing stocks to buy, go with the one that has a history of moving higher. Ride the trend!
Robotic Investing
Jeremy is an investor just like you who is trying to maximize his portfolio returns so he can retire. Over at Robotic Investing, he has developed a systematic approach to investing that uses trend following and statistical analysis to identify high probability stock trades. Coupled with his portfolio management approach, the system has been able to generate returns in excess of the market on a consistent basis.
(Photo Credit)
Tags: AIZ, BRC, RCL,TWC, CAG,
