What are we looking for?
Dividend-paying companies that are financially healthy.
Today I use Morningstar CPMS to look for companies that are in a strong financial position and pay a higher yield for investor looking for consistent cash flow.
In order to identify companies that have a higher distribution, I placed a lower limit of 3.5 per cent on the dividend yield. (The yield on the S&P/TSX Composite Index is 2.8 per cent.)
I used the Morningstar Quantitative Financial Health Score to make sure that we’re identifying companies with strong balance sheets. This is a proprietary variable that measures the likelihood that a company will fall into financial distress. I used the interest coverage ratio, where calculable, to make sure that the companies can easily pay the interest on outstanding debt while having enough money to distribute to shareholders. This metric is calculated by dividing a company’s earnings before interest and taxes by the company’s interest expense over the same period. (Where interest expense is virtually zero, as with banks, for example, the ratio was not calculable.)
I’ve added three factors that focus on earnings. The annual and quarterly earnings momentum, along with the quarterly earnings surprise, will indicate whether companies are increasing earnings and beating analyst expectations. (Annual and quarterly earnings momentum is rate of change of annual or quarterly operating earnings per share. Earnings surprise is a proprietary measure of the percentage difference between actual and forecast analyst earnings for the latest reported quarter.)
The goal is to find companies that are financial healthy with strong earnings that can translate into higher income from dividends for investors. We ranked our universe of 700 TSX stocks based on the above factors. We then applied four screens to create our list of stocks:
- Market capitalization above $500-million;
- Yield greater than 3.5 per cent;
- Morningstar Quantitative Financial Health score greater than 0.6;
- Five-year beta of 1.2 or lower (measures an asset’s risk relative to the market over the past five years; a beta of one indicates the stock moves in tandem with the S&P/TSX).
What we found
I used CPMS to back-test the strategy from June, 2012, to February, 2021. During this process, a maximum of 10 stocks in the TSX were purchased and equally weighted. Stocks would be sold if their overall rank dropped out of the top half of our list. The portfolio is rebalanced monthly and the strategy produced an annualized total return of 11.3 per cent since inception whereas the S&P/TSX High Dividend Index advanced 6.7 per cent on the same basis. Today, the stocks that qualify for purchase into the strategy are listed in the accompanying table. They have an average yield of 4.1 per cent, or 1.3 percentage points higher than that of the S&P/TSX.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments shown here.
Phil Dabo, MFin, is a vice-president of business development at Morningstar Research Inc.
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