Dividend Drill Return Model

From "The Ultimate Dividend Playbook" by Josh Peters

Stocks, like any investment, only have value because of their ability to return cash to their owners - if not now, then eventually.

Income
We should rely on cashflow from assets, rather than selling of assets, to attain our financial goals.

Insight
Dividends provide signals such as the company's financial health, growth prospects and confidence of the management in the company.

Independence
By managing a portfolio based on dividends, the investors can achieve psychological independence to ride out short-term market volatility.

Dividend Drill Return Model

Dividend rate ($)
divided by: Share price ($)
= dividend yield (%)
---------------------------
Core growth estimate (%)
divided by: ROE (%)
multiplied by: EPS ($)
= Cost of growth
---------------------------
EPS ($)
minus: dividend ($)
minus: cost of growth ($)
= Funding gap ($)
---------------------------
Fundung gap ($)
divided by: Share price ($)
= Share change (%)
---------------------------
Core growth (%)
plus: Share change (%)
= Total dividend growth (%)
----------------------------
Total dividend growth (%)
plus: dividend yield (%)
= Projected total return (%)

Margin of safety: Look for a forward-looking total return prosepect higher than you might be willing to accept if the future was certain.

Assessment of Dividend Safety
1. Are earnings sufficient to cover dividend?
2. Are earnings stable enough to cover the dividend amid short-term variation?
If not, does the company have access to other resources to fund the dividend?
3. Are earnings durable enough to cover the dividend for the foreseeable future?
4. Is the management not only able but willing to maintain current dividend payments when the going gets tough?

Durability implies:

- A firm can take a financial punch in one year and come back swinging the next.

- An earning stream that, if not quite predictable in any one year, can be relied upon over a series of years, during which short-term fluctuations should be averaged out.

Factors affecting durability:
1. Economic moat

2. Long-term demand

3. Liquidity

To know about earning prospects:
1. Management guidance
2. Analysts' consensus
3. Trailing earnings
4. Own forecast

Factors affecting earnings stability:
1. Revenue fluctuation
2. Operating leverage
3. Financial leverage

Warning signs:
1. Unsustainable earning sources
2. Excessive debts
3. Legal problems
4. Peer pressures

It would be easy to invest solely on the basis of historical trends in dividend growth but a changing situation can easily render the past irrelevant.

= = = = =

Simplified Gordan's Dividend Discount Model:

P = Div/(r - g) ; where Div = expected next dividend payment
r = (Div/P) + g

Since sustainable growth, g = (1 - dividend payout) * ROE

Prospective return = expected dividend yield + (retention ratio * ROE)