In my initial Rising Stars article, I revealed that I'm constructing a diversified, well-balanced, complete (multivitamin?) portfolio. All of our buy candidates will come from various screens I'll be building.
Today we'll jump right in with our first screen and get a list of candidates to consider. To start off, we'll be looking for a solid and stable dividend payer that could be the anchor of our portfolio for years to come. This will be perhaps our "safest" pick. I want the company to be in excellent shape financially and to have a history of increasing dividends -- which we'll be reinvesting back into the stock.
Wharton professor Jeremy Siegel has really laid the groundwork for successful investing through all market cycles. In one of his studies covering the period 1871-2003, he found that 97% of the total after-inflation accumulation from stocks came from reinvesting dividends. Only 3% came from capital gains. The fact that dividends, in one form or another, make up 97% of historical returns is one big reason dividend payers -- and our reinvestment in them -- will play an important role in our portfolio.
Why is such a simple thing so incredibly powerful? Dividend-paying stocks act, in Siegel's words, as "bear-market protectors" and "return accelerators." When dividends are reinvested, they purchase more and more shares at lower prices during a bear market. These extra shares act as a bear-market protector. Then, when share prices reverse, the extra shares act as a return accelerator and rocket total returns higher.
If you need more proof, consider that the 20 best-performing survivor stocks in Siegel's study from the original S&P 500 in 1957 are all dividend payers -- names like Altria, Abbott Labs, Bristol-Myers Squibb, Tootsie Roll Industries, and Coca-Cola.
Corporate El Dorados
Siegel also found some other common characteristics of these 20 top long-term performers -- or "corporate El Dorados," as he calls them. The most important is the ability to deliver greater-than-expected earnings growth on a consistent basis. Carrying an average price-to-earnings ratio slightly above the market average, these companies weren't exactly cheap on a traditional basis. But throughout the years, they always seemed to deliver a bit more than the market expected.
Also, most of the top 20 marketed famous consumer brands or were pharmaceuticals. Brands like Coke, Pepsi, Marlboro, and Wrigley have strong moats because of products consumers are willing to pay a little bit more for. As Charlie Munger once described, if you walk into a store and see Wrigley chewing gum selling for $0.40 and Glotz's gum selling for $0.30, you're not going to flinch at paying that extra "lousy dime" for a product you know and trust. But those dimes add up significantly for Wrigley over the months!
Now that we know what we're looking for, it's time to put together our screen. As I mentioned, our company will be a large cap with a history of dividend increases. It will have a strong balance sheet so we don't have to worry about it getting into any trouble during hard times (as so many companies did in our most recent crisis). We'll also want businesses with a history of consistent earnings and dividend growth.
So we'll obviously start with all dividend-paying companies on major U.S. exchanges. Here are the rest of our screening criteria:
- Market cap greater than $20 billion.
- Total debt-to-capital ratio less than 60%.
- Average annual earnings-per-share growth over the past 10 years greater than 5%.
- Projected annual earnings-per-share growth over the next five years greater than 5%.
- Positive dividend growth over the past five years.
The screen produced exactly the type of companies you'd expect, along with a few lesser-known businesses. I'll put the complete list of 57 passing companies on our discussion board, but here are several that fit our corporate El Dorado profile:
Market Cap (Millions)
5-Year Growth (Projected)
|ExxonMobil (NYSE: XOM )
|IBM (NYSE: IBM )
|Procter & Gamble (NYSE: PG )
|Coca-Cola (NYSE: KO )
|PepsiCo (NYSE: PEP )
|Abbott Laboratories (NYSE: ABT )
|3M (NYSE: MMM )
Data provided by Capital IQ.
We'll consider all the companies that passed, but more than likely one of these blue chips will be the first stock in our portfolio. I'll take you through the steps and make the actual purchase in our next installment later this week. Until then, drop by the discussion board to voice your opinion!