Investing by the Pool

The other day I was struck by the particular brilliance of one my tweets.

Fortunately, Gunnar Peterson of the Motley Fool was kind enough to expand on what I said.

By insisting on a 3% dividend you limit your choices to companies that pay out over 50% more than the current S&P 500 dividend payout. Furthermore, this helps investors avoid speculative situations. Checking the debt level gives the investor a margin of safety, as the company’s balance sheet should be ready to weather tough times.

I’m not much of a fan of stock screeners. Perhaps screeners can be used as a first hurdle in selecting good stocks, but I think they’re too mechanistic.

Successful investing basically boils down to buying high-quality companies at cheap prices. The problem is that high-quality companies are usually rather expensive. The good part is that the stock market isn’t always so rational, and if you’re patient, you can eventually see a good stock at a low price. Again, if you’re patient.

Personally, I have a large Watch List of stocks that I keep an eye on. These are stocks that I’ve judged to be of superior quality. The Watch List is sort of the minor leagues for our Buy List. At the end of the year, if a Watch List stock falls to a cheap price, it then becomes a candidate for our Buy List.

Back to my tweet. The idea I tried to convey is that investors should focus on well-run companies going for good prices. The dividend yield part of the equation will generally, but not always, show us bargain stocks. Companies with low debt will generally, though not always, signal that they’re well run.

I ran a screen of just S&P 500 companies with dividend yields over 3% and zero long-term debt. The four companies I got were Paychex, Garmin, Coach and GameStop. But even that’s a little misleading because Garmin is on track to pay out more than 60% of its earnings as dividends. That’s nearly twice the rate of the S&P 500. Coach will probably pay out 70% and Paychex will be near 80%. Only GameStop is near reasonable territory at 36%, and there are serious questions about the sustainability of their business model.

Gunner ran a similar screen (thought he used low debt instead of zero debt) and came up with three stocks; AstraZeneca, Procter & Gamble and Unilever. He also wisely advises investors to be wary of any stock with a dividend yield greater than 6% or 7% and payout ratios over 70%. Honestly, there are a zillion different screens you can run, but it should always reflect the simple equation of high-quality and low cost.

Posted by on August 7th, 2014 at 11:18 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.