7. Bringing It Together

Now we have covered the value dividend strategy in detail. If you followed along and find the idea of blending value investing and dividend investing to achieve higher returns interesting, you will be inclined to get started and apply a value dividend approach to your portfolio.

But before you start, I want you to be sure that the Value Dividend Strategy is right for you.

First you have to be certain that the Value Dividend strategy fits your investment approach. As I’ve laid out, investing in value stocks comes – compared to holding an index portfolio or an overall value portfolio – with a higher risk. Especially with non-dividend paying stocks, you could lose the bulk of your investment, if you get into the market at the wrong time (for example just a moment before the market crashes).

You should only consider the value dividend strategy when you are able and willing to commit a significant amount of your time each year into the active management of your value dividend portfolio. This includes the screening of the market and also intense due diligence of relevant companies and their respective industries.

If this does not sound like you, you should consider a more passive value investing approach. For now, this could mean investing in a value ETF and a dividend ETF. Who knows, maybe one day someone will offer a Value Dividend ETF or at least a virtual portfolio which you can mimic.

If you are certain to give it a try and actively invest your money or start by creating a virtual value dividend portfolio, you can follow the following steps which might help you get started.

Creating Value Dividend Portfolios

Step 1: Define your aim

First, you will want to define your aim. Do you want to create a large diversified portfolio with more than 20 stocks or find one, two, or three attractive value dividend stocks you want to invest in?

Step 2: Screen the market

The first step is to screen the market. For this, you want to use an advanced stock screener where you can use multiple filters. I like gurufocus.com, which is a paid screener targeted at value investors. But you can use any screener you prefer or have access to. In the appendix you can find a list of stock screeners you can try.

The following inputs are important when you screen the market:

  • Industry or Industry Classification Code (ICB)
  • Price
  • Market Value
  • Price to Earnings Ratio (P/E Ratio)
  • Price to Book Ratio
  • Price to Cash Flow Ratio
  • Dividend Yield
  • Dividend Payout Ratio
  • Free Cashflow per Share
  • Share Buyback

Depending on the screener, you will either want to include the following ratios which will help during your screening and due diligence process:

  • Altman Z Score
  • Free Cash Flow Payout
  • Net Financial Debt to Total Assets
  • Credit Rating
  • Gross Profitability Ratio
  • Piotroski F-Score
  • Return on Invested Capital (ROIC)

Step 3: Filter the results

Filter out banks, insurances, and financial service companies. Also in my initial study I left these financial companies out, as it is difficult to compare these types of companies with other businesses merely on financial metrics such as the price-to-book or price-to-earnings ratio.

Step 4: Sort the results

Next, you want to sort or filter the results according to the dividend yield and the Price-to-book ratio. You can do so by either filtering the results so that your results only contain companies with a specified low price-to-book ratio and dividend yield, or you sort all search results accordingly. 

Step 5: Create portfolios

Now you can include all search results which fit your definition of a value dividend stock, into a portfolio. You can either create an overall value dividend portfolio, which means that you include both: highly dividend paying and non-dividend paying stocks into one portfolio. Or you split it up so that you end up with two portfolios: one value portfolio which pays a significantly high dividend and one value portfolio which pays no dividends.

Step 6: Due Diligence

Now, you most likely ended up with one or two portfolios consisting of 5-35 value dividend stocks. As explained in the chapter “Intrinsic Value Analysis”, you should look at each stock individually and calculate an intrinsic value.

If you use a more advanced screener, you can already export important indicators such as the Altman Z score, Piotroski F-Score, and custom ratios such as the free cash flow payout ratio. They can help you to already sort out many bad companies.

If there are companies whose metrics are too good to be true, it is usually true. Look at them individually, their last quarterly and annual report, and may find that they sold a business division which can easily screw certain metrics.

Of those companies which are left, you’ll want to continue with your own due diligence. Try to understand the business and industry, get a clear picture of the management, and calculate an intrinsic value with a method you find appropriate.

Step 7: Create Investment Portfolios

Depending on your investment approach, you’ll have a few selected or a few dozen stocks left, in which you can invest. My Value Dividend study was based on larger significantly dividend paying and non-dividend paying stocks. Mostly in the region of 8 to 30 stocks per portfolio. It depends on you as investor whether you prefer a larger diversification or – if you found a golden opportunity – invest in a single or a selected few of value dividend stocks.

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Dos and Avoid’s in 2022/2023

As we have learned in previous chapters, the year 2022 and 2023 are different. This is why it is important to factor in all risks but also all opportunities of today’s geopolitical and economic environment.

If you build a Value Dividend portfolio, please keep in mind that with a changing geopolitical environment, a value dividend strategy cannot be the sole strategy to navigate the troubled waters of 2022 and 2023. It is reasonable to selectively invest in undervalued but also reasonably valued companies which have a clear pricing power, deliver solutions for the energy transition, or selected commodity and technology stocks  – irrespective of their dividend yield. 

What follows is an overview of things to prefer and avoid. Still, ideally we focus on value stocks which pay a significantly high dividend or – after we reached the bottom of a recession – no dividends at all.

Do

  • Rebalance your portfolio towards an overall value portfolio or by investing in a value ETF (i.e., Vanguard Value ETF)
  • Improve your portfolio by focussing on value stocks which pay a significantly higher dividend – but do your due diligence
  • Invest in stocks and prefer:
    • Value-Dividend-Stocks: stocks which are undervalued (low price-to-book-ratio) and pay an outstanding high dividend,
    • stocks within the security industry,
    • companies which have pricing power,
    • companies delivery solutions for the decarbonization and energy transition:
      • Climate Action
        • Solar
        • Wind
        • Batteries
        • Storage
        • Electric Vehicles
        • Distributed Generation
        • Energy Efficiency
      • Energy Transportation
        • Pipelines
        • Power Grids
        • Supply Chains
    • undervalued dividend paying commodity stocks including:
      • energy stocks (natural gas, oil, gasoline, etc.)
      • agricultural and food stocks,
      • rare metals needed for the energy transition, especially Cobalt, Copper, Graphite, Lithium, Nickel, Silicon, and Zinc
    • stocks with collateral-based cash flows,
    • innovative technology companies with a 10x technological advancement (monopolies),
    • companies which will profit from a strategic realignment towards domestic manufacturing.
  • Hedge against a serious recession or stagflation in Europe by:
    • diversifying your Euro or Dollar holdings into foreign non-Euro and non-USD backed currencies,
    • investing in physical gold,
    • investing in commodity stocks or ETFs (see above)
    • short positions against European industrial companies which, due to a dependence on cheap Russian gas, will unlikely survive this market cycle (do your due diligence)

Note: Only invest in companies you truly understand and can evaluate. For most people, it will be best to invest in corresponding ETFs, instead of trying to pick stocks. For example, hold a small basket of ETFs instead of buying individual stocks:

  • High Dividend Yield ETF (i.e., Vanguard High Dividend Yield ETF)
  • Value ETF (i.e., Vanguard Value ETF)
  • Energy Transition / Climate Change ETFs (i.e., iShares Global Clean Energy ETF)
  • Commodity ETF (i.e., iShares Diversified Commodity Swap UCITS ETF)
  • Gold ETCs (i.e., iShares Physical Gold ETC or Xetra-Gold)

In addition, one can buy selected few technology growth stocks. These should already have a monopolistic advantage, meaning their market share is significant, and their technology is far and away the best. There are also security and defense ETFs, such as the iShares U.S. Aerospace & Defense ETF, but this comes with an ethical dilemma and every investor needs to decide on his own.

Avoid

  • Avoid European (industrial) companies whose business relies on cheap Russian gas
  • Avoid companies who are overly reliant on suppliers in Taiwan (i.e., on Taiwanese semiconductors)
  • Avoid Taiwanese and Chinese companies
  • Avoid companies with a large lower-wage workforce and limited pricing power,
  • Avoid companies which might have trouble passing on higher input costs (i.e.; energy) to a small but powerful customer base,
  • Avoid companies which manufacture non-premium non-essential consumer goods,
  • Avoid premium consumer goods.

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