In Brief
An income screening approach outlined in the "Little Book of Big Dividends" that is focused on stocks with low dividend payout ratios as well as nine other fundamental (and momentum) based criteria.
Background
Charles Carlson is the CEO of Horizon Investment Services, an investment advisory business, and Horizon Publishing, a publisher of investment newsletters. Horizon's flagship publication, Dow Theory Forecasts, is one of the longest-standing investment newsletters in the US.
In his enjoyable 2010 book, "Little Book of Big Dividends", he outlines a quantitative system for income-hungry investors looking to construct a portfolio that generates big, safe dividends easily through his BSD (Big, Safe Dividends) formula.
How It Works
In the book, Carlson discusses two approaches - the basic BSD formula and the Advanced BSD version. We focus in this article on the Advanced BSD version.
This is because, other than the payout ratio, the basic formula relies entirely on what he calls the Quadrix® ranking system. Quadrix is a somewhat "black box"-ey quantitative scoring system which ranks stocks based on more than 100 different variables across six categories, including Momentum (e.g. growth in earnings, cash flow, and sales), Quality (e.g. return on equity & return on assets), Value, financial strength, earnings estimates & relative stock price performance. The idea with Quadrix is to focus on stocks that score in the upper quartile (75 and above out of 100).
While these rankings are available for US stocks, they are not available for foreign stocks. As a result, we focus on the Advanced Formula since that provides a lot of interesting quantitative "meat" that can easily be measured for UK stocks.
Screen Criteria
The Advanced BSD formula uses the following 10 fundamental and momentum factors with different weightings for each factor to arrive at a composite BSD score.
Primary Factor
- Payout Ratio (30% Weighting) - In Carlson's methodology, the most important criterion (making up almost a third of the total weight) is the dividend payout ratio – the annual dividend divided by the earnings per share. He sees this as a powerful tool for spotting companies that can maintain and grow their dividends. A modest payout ratio gives the company the ability to maintain its dividend even if earnings happen to hit a rocky patch.
Major Factors
- Interest Coverage (10% Weighting) - This is considered an important factor as companies with lots of debt may struggle to pay the dividend if business conditions deteriorate. Interest…
