Originally posted on Forbes.com.
Now Is The Time To Get Your Buy List Ready
Safety is on everyone’s minds these days, for good reason. In just 23 trading days from the market high of Feb. 19, 2020, to March 23, 2020, the stock market fell 34%. Over the next 13 trading days, from March 24 through the end of last week (April 9, 2020), it retraced 50% of that decline.
The Market Is Moving
The market is moving fast, and it’s very volatile. Over the past few weeks, we’ve seen a down day of 12% (March 16, the third worst since the 1920s) and an up day of 9.4% (March 24, the ninth best historically). Read “The Coronavirus Stock Market: A Market Gone Wild” for more details.
Should Investors Be Buying Now?
A self-directed investor acting on his or her own may still be fearful. Professionals are in a different place: watchful for opportunities the beaten-down market offers. Some with a “risk-on” temperament might be buying with conviction; others who are more neutral are buying over time; and of course, some are still in “risk-off” mode.
Perhaps the middle ground could be the place to be.
Years ago, I used to visit the library to read The Value Line Investment Survey. Founded in 1931, Value Line is the essential independent resource available to both professionals and everyday investors alike.
Now, that survey is available online, which makes it a lot easier to screen for stocks based on any number of historical and forward-looking characteristics. The online version has the advantage of providing all of the same reports that I used to read at the library, with the added benefit of tools, such as pre-built stock and industry screens, model portfolios, a portfolio tracker and the screening tool that we will discuss here — a decided advantage for someone who wants to create a watch list of stocks to buy when the time is right.
I asked Ian Gendler, Executive Director of Research at Value Line, how he would screen for high-quality dividend payers that could be expected to keep up their dividends in a pandemic market and beyond.
Keep in mind that screens are the starting (not the ending) point for a list of stocks to buy.
Value Line Concepts
Before sharing Gendler’s screen, let’s talk about how Value Line “thinks.” Value Line uses proprietary ranks and ratings that need to be understood before creating a screen. Value Line ranks stocks relative to each other based on expected price performance during the next six to 12 months, but that’s not all. Value Line also ranks for overall risk.
Let’s start there with risk. Value Line measures risk on a relative basis — that is, relative to the other stocks in its universe of 1,700. That measure is reported as a “safety rank.”
In the Value Line system, each stock is given a safety ranking from 1 to 5, with 1 being the most safe. “The 1s are the safest stocks in our coverage universe and tend to hold up better in down markets, and meaningfully participate in bull markets,” explained Gendler.
That’s what we want in this market: stocks that tend to be less volatile, yet have upside potential.
The safety ranking is based on price stability and financial strength. The price stability index measures “a relative ranking of the standard deviation of weekly percent changes in the price of a stock over the past five years.” While price stability takes in the recent coronavirus market, since it uses five years of data, just a few weeks of volatility may not meaningfully alter the price stability score all that much, explained Gendler. Rankings are updated on the website on Monday mornings around 8 a.m.
The “financial strength” rating is Value Line’s assessment of a company’s financial risk, including “balance sheet leverage, business risk, the level and direction of profits, cash flow, earned returns, cash, corporate size and stock price.” That’s another plus: Stocks that have financial strength potentially have a better chance of holding up during an economic downturn.
These and other rankings are described in “The Value Line Ranking System,” which you can find online.
Since we’re talking about dividends, we also want to understand the payout ratio, which is the ratio of dividends paid divided by net income. The higher the payout ratio, the greater the risk that a company may not be able to keep up the dividend payout if economic conditions worsen.
Value Line has its own term for payout ratio called “Percent Distributions to Net Profits,” which includes preferred dividends as well as regular common stock dividend distributions divided by net profits.
We also need to know how much debt the company is carrying. If debt is high, a potentially problematic economy ahead may inhibit the company’s ability to raise capital through a debt offering, should it need to do so, thus potentially suppressing growth, or worse, losing ground.
The Gendler Screen
Here is Gendler’s screen for finding safe, high-quality stocks that can potentially preserve their dividend payouts:
- Safety Rank = 1
- Dividend Yield greater than 3.5%
- % Distributions to Net Profits of 65% or less for “Next Year”
- % Long-Term Debt to Capital 50% or less for “Next Year”
Notice that the last two filters are for next year, based on Value Line’s forecasts. The screener also allows you to filter for “3 to 5 years out” or for “last year.”
I used the Value Line Stock Screener Tool to execute the screen in four steps. You can follow along using the free trial.
Results From The Gendler Screen
Here are the results from the Gendler screen that I ran on April 13, 2020. Keep in mind that you’ll different results as markets and data points change.
Filtering the 1,700-stock database for only those stocks with a safety rank of No. 1 resulted in 117 stocks as of today (April 13, 2020). If you are following along with the free trial, take some time to explore these stocks before going any further. Click on the Ranks & Ratings tab; you’ll see that all of the stocks that passed the safety screen have “A” or better financial strength ratings (A++ is the highest rating; ratings range from C to A++ in nine increments).
Other tabs give you estimates and projections (including the current dividend and projected dividend growth rates); profitability; annual rates; and industry statistics.
I added a dividend yield criterion of 3.5% or greater, narrowing the field to 28 stocks as of April 13.
Next, I added the payout ratio (% Distributions to Net Profits - Next Year) of 65%, filtering for payout ratios of less than 65%. That level or lower is an extra layer of conservatism that the companies will be able to pay their dividends even if earnings decline significantly. This narrowed the list to 8 stocks.
Long-Term Debt To Capital
Finally, I filtered for the last criterion, long-term debt to capital of less than 50%. Now, only four companies remained: Emerson Electric (EMR), Genuine Parts (GPC), Pfizer (PFE), and AT&T (T).
Not A Buy List, Yet
Keep in mind that this is not a BUY list. It’s a RESEARCH FURTHER list. Screens are the first step toward a buy list. The list is a start for doing further research.
Now, On To Research
Research brings me back to my library days. All of the reports that I was familiar with are now online (Ratings & Reports; Selection & Opinion; Summary & Index) – and more. Explore “tool guides” to become familiar with these and other resources. “How to Read a Value Line Report” will be most helpful to familiarize you with Value Line’s data presentation.
When To Buy
Before buying a stock, consider whether this is the right time. Value Line has a rating for when to buy, called Timeliness: “Investors should try to limit purchases to stocks ranked 1 (highest) and 2 (above average) for timeliness.”
Timeliness is “The rank of a stock’s probable relative market performance in the year ahead. It is derived via a computer program using as input the long-term price and earnings history, recent price and earnings momentum, and earnings surprise. All data are known and actual. Stocks ranked 1 (highest) and 2 (above average) are likely to outpace the year-ahead market. Those ranked 4 (below average) and 5 (lowest) are expected to underperform most stocks over the next 12 months.”
These four stocks from the Gendler screen all have a Timeliness rank of 3, which is average; in Value Line’s words: “Stocks ranked 3 (average) will probably advance or decline with the market in the year ahead.” That’s not a bad place to be for a cautious investor.
Of course, if you are eager to buy now, you can redirect your search to start with a screen of stocks rated No. 1 for Timeliness. But watch out for safety as well. We’re still in a very volatile market, even though the VIX, a measure of volatility, has calmed down somewhat (but hardly enough) from previous weeks.
You may need to take a stand: Do you want to find potential big movers? Or more slow and steady stocks? Value Line will help you do both.
We’ll review more stock screeners in future posts. In the meantime, take this survey your experience with stock screening to share your thoughts on this post.
Don’t hesitate to email me (firstname.lastname@example.org) with questions.