Podcast # 127
3 August 2023
SAFE DIVIDEND INVESTING
PEDICTING STOCK PRICE INCREASES.
ARE STOCK ANALYST RECOMMENDATIONS IMPORTANT?
Greetings to listeners all around the world. Welcome to Safe Dividend Investing’s Podcast # 127, on August 3rd of 2023.
My name is Ian Duncan MacDonald. In today’s podcast, I will be answering 2 interesting investment questions.
The objective of my books, my website and my podcasts are to show all those seeking financial independence how to become informed, confident, successful self-directed investors.
Question 1
How do I know before I buy a stock that it will increase in value?
No one can accurately predict what will happen to any stock price. However, you can feel confident about your choice of a stock by using some simple scoring tactics and looking at historical trend data.
To overcome your fear of making a stock buying decision, you must accept that “the perfect stock” does not exist. Choosing one stock is always a judgment call in which you compare what you feel are your best possibilities in your selection of many stocks. With 20 carefully chosen “good” stocks in your portfolio, you are greatly increasing the possibility of success for your total portfolio.
You will find some of the stocks you thought were outstanding will prove, over time, to be mediocre and others that you thought to be a marginal choice will be outstanding. Over the years every stock will have its ups and downs.
It is the total performance of your portfolio that is important, not its individual stocks. One stock that performs below expectations will barely impact the overall performance of your carefully created portfolio. Your objective is to create a portfolio that will give you both dependable ever-increasing share prices and dividend payouts.
It is not extraordinary to realize an annual dividend income worth 6% or more of your portfolio, nor to see the total value of your portfolio increasing by 12% each year. However, do not look for increases in the portfolio’s value during market crash years, when its value could drop by 20% or more but you will find that your dividend income is not impacted by market crashes. Dividends are paid out of profits controlled by the company’s executives not out of share prices controlled by speculators.
By only considering financially strong, stocks, paying dividends in excess of 3.5%, you will be able to keep you portfolio ahead of inflation. Over the last 100 years inflation has averaged about 3.5%. Since dividends are paid out of profits, dividends also help ensure that you are only investing in financially strong companies. When you buy shares in a historically strong company you are really buying the skills and the experience of its executives who have successfully handled the challenges in an ever changing competitive world.
When I select a stock, I have in mind the trend history and scoring data of an outstanding strong stock, I am familiar with. You too should find such a model stock to compare with the stocks you are considering.
The following is the data for my model stock that I compare to all prospective new purchases. It is an actual stock displayed on page 428 of my book American High Dividend Handbook. I send those who buy my books, on request, the simple stock scoring software used throughout the books so they can update scores or score any stock they encounter. All the books have a chapter that describes in detail how the scoring matrix works.
Things are neither good nor bad except by comparison. Calculating a score helps you sort stocks you are considering from most to least desirable.
My model stock has a score of 67. That isn’t the highest score but it is a very good score compared to most stocks. Most stocks score below 50. I personally avoid investing in stocks scoring less than 50.
My model stock’s share price is $77.86 cents which makes it highly priced but not the highest. Over the last four years the share price has increased by a bit more than 10% which means it is trending in the right direction. Higher priced stocks tend to score better than lower priced stocks. Most stocks scoring less than 40 cost less than $25.
*The “book value” of my model stock is about half the value of the share price, which is better than the average book value to price comparison but not as outstanding a positive as those rare “bargain” stocks whose book value is greater than the share price.
Its dividend yield percent of 5.50% is not the highest but is respectable. Between 5% and 10% is acceptable. Dividend yields over 10% often indicate problems with the stock and require close scrutiny.
Five analysts were recommending the model stock as a buy. No analysts were rating it a strong buy. It is rare to see a “strong buy” rating but when you do see it, that is a strong positive. Some analyst was willing to risk his reputation by making such a call.
Unfortunately, most stocks are ignored by analysts, so it is a positive sign when they get any attention. While analyst price forecasts are usually only about 50% accurate, they do encourage some investors to buy the stock. Since we are looking at purchasing stocks, whose value we expect will increase in price, we cannot ignore analyst recommendations.
The model stock’s operating margin was 46.30% which once again is not the highest but is certainly higher than average. This indicates a company whose executives know how to generate sales, control expenses, and make a profit. The purpose of every company is to make a profit.
The daily shares traded of my model stock are in the 800,000 range which is much higher than normal. The trade volume indicates a vibrant company whose shares will be easy to acquire. Stocks trading less than 100,000 shares a day often struggle to get investor’s attention which does impact share prices.
With a price-to-earnings ratio of 59.8x it is a higher ratio than most stocks but is not into the stratosphere like you find with some hot tech stocks. Unfortunately, those with price-to-earnings ratios in the hundreds (or even thousands) can see their ratio plunge as quickly as it rose to those lofty heights. Usually the lower the price-to-earnings ratio the safer and the greater the potential for profits.
The most important consideration for my model stock is its historical trends. In 2001 this company was paying out a dividend of 42 cents. It rose to 56 cents in 2011. Then to 98 cents in 2016 and was at $1.05 in 2021. The executives of the company control the dividend payout. They often take pride in being able to increase the dividend payouts year-after-year.
While share prices are controlled by speculators, they too had a similar upward steady trend. The share price was $21.81 in 2001, $38.27 in 2011, $66.65 in 2016 and $77.13 in 2021.
Rising share prices often impact dividend payouts. When share prices increase, the dividend yield percent automatically drops. This forces executives, intent on maintaining a steadily rising dividend yield percent, to increase the stock’s dividend payouts to maintain a steady dividend yield percent. You will notice this occurring with banks who are competing for investors.
After you buy a stock, it would be unusual if that stock’s share price did not fluctuate above and below the price you paid for the stock. Stocks rarely, if ever, rise in straight line. The share price drops may make you feel like you are treading on thin ice. It is only as time goes by that you will see that your share price and dividend payouts are gaining. You will then recognize that you can depend on the income from this stock. This will negate the fear that many retirees have of outliving their retirement savings.
All the historical stock information you need to find good stocks is available from the online trading platform of your financial institution or from such websites as Yahoo finance. It is critical that you use the data to understand what you are investing in and why you chose that stock. To blindly leave your investment decisions to others is both dangerous and unnecessary. It takes only a few minutes to research a stock.
Years can go by before you might have to replace any of your carefully chosen stocks. The only reason I replace a stock is when the score drops below 50 while at the same time the dividend yield percent falls below 5%. This rarely ever happens.
You too can be an informed, confident self-directed investor.
Question #2
Why do you include analyst buy recommendations in your stock scoring?
Many years ago, when I was building the scoring system, I thought long and hard about including analyst "buy" and "strong buy" recommendations in my scoring matrix. At that time, I was using the data supplied by Thomson-Reuters, who supplied it to TD Bank. They were then very definite about showing the stock recommendations by analysts as a "buy" or a "strong buy'. This made it easy to calculate a score. However, a few years later, they stopped separating them into two categories and only showed buy recommendations.
This forced me to now come up with a definition for a "strong buy". I came up with the rule that if the projected share price for an analyst’s buy recommendation was 50% higher than the current share price, this would make it a “strong buy” recommendation.
There are few "strong buys". The rule now forces those who use the scoring software to take a few seconds to check the prices of each "buy" recommendation. However, there is now a logical explanation of what is a strong buy recommendation. This is better than just blindly accepting what each analyst used to classify as a "strong buy".
Further research has shown me that at best analysts are only about 50% accurate in their prediction of future share price. This does not surprise me. If they were 100% accurate in their guesses, they would be incredibly wealthy and not be working as analysts.
You might ask, why even include buy recommendations in a stock score? Recommendations are included because they do influence some investors to buy a stock. They cannot be ignored no matter how fuzzy and unreliable they may be. Stock buying does impact share prices.
The IDM stock scoring system is not only trying to predict a reliable dividend income but also that share prices will increase.
How analysts come up with their recommendations or why they choose to analyze some stocks and ignore others is not self-evident. They seem to concentrate their attention on stocks that are most popular with speculative investors. The popularity seems to be based on stock trading volumes. However, just because analysts ignore a stock does not necessarily mean it would not be a good stock to own. This can be seen with those stocks scoring highly without any analyst recommendations. Their recommendations are only one of the eleven factors in the stock scoring matrix.
Analyst "sell" and the "hold" recommendations are ignored in the scoring system because the primary purpose of analyst recommendations is to identify buying influences. Sell and hold recommendations are no more helpful in making a buying decision then if no recommendation is being made.
A "buy" recommendation can result in between 1 to 5 points in a total score, as can a "strong buy". However, fewer strong buy recommendations increase the score higher than just a regular buy recommendation. To see exactly how the scoring system works go to one of my books.
There probably is no such thing as a perfect scoring system but as imperfect as any measuring system may be, as long as the data is scored, in a consistent manner, it allows you to compare the potential of one stock with another. This then allows you sort what is being considered by desirability.
What I have learned from the scoring system is that stocks paying higher dividends usually have lower scores than stocks paying lower dividend yields. In your portfolio of 20 stocks you need both higher and lower scoring stocks to arrive at a safe balance that will give you a consistent “good” dividend return and protect you from those odd stocks that deviate significantly from their historical positive patterns.
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