Rating Methodology


Ideally, we would like to invest in stocks that:

  • Are committed to pay sufficient dividends and steadily increase the payouts in the future
  • Increase the dividend fast enough so that we enjoy not only the dividends, but also the share price appreciation resulted from bigger dividends.
  • Have a strong financial structure to sustain long term dividend payouts for years to come.
  • Have strong profits to keep their financial structure anytime soon.
  • Have reasonable valuation so we don’t overly worry about loss of principals during market downturns.

To satisfy the above requirements, we start with all stocks that have been paying consecutive increasing dividends for the past seven years, and develop this rating system that have five components. A stock can earn at most one star rating from each of the five components.

We try to be conservative for a stock to earn a full star, i.e. a stock has to be really good to earn full star in each component. The conservativeness leaves safety of margin for both us investors and the companies to make mistakes. Even if the companies don’t develop in the future as we expect, the investing results will not be devastating.



Dividend Growth Component

This component contains three checks. two of the three checks have to be true to earn a full star. If only one of the three checks passes, earn half star. Zero star is earned if none of the three checks are true.

  1. Minimum Dividend Growth Rate in the Past 7 Years + Current Yield ≥ 12% The minimum dividend growth rate is the minimum annual dividend growth rate for the past 1, 3, 5, 7 years. So if a stock had a tough time in its past seven years history, it will be reflected in the dividend growth rate.

  2. Dividend consistency: rolling 4 years growth in the past 7 years ≥ 15% We want stocks not only increasing dividends in the long run but in a consistent pace when look at each 4 years window. The bar is quite high here, again showing the conservativeness of this rating system. Hyper dividend growth stocks, just start paying low dividend yield but increase at 15%-20% annually, will likely pass this check. This check also provides a second chance for stocks failing the first check - Some may have raised slowly for a particular year but when looking at 4 years window they may pass.

  3. Years of Dividend Growth ≥ 15% Although all the stocks we include here have at least 7 years of non-decreasing dividends history, the longer the company keeps doing that, the better.



Dividend Income Component

This component contains two checks. Passing either one earns half star. Dividend investing has opportunity cost, i.e. you could earn income by putting the same amount of money into alternative income investments, like bonds. Since the 40 years big bond cycle peaked in 2020, the bond market becomes very investable. Why do you invest in dividend stocks if bonds can provide similar level of income and less risk? We normally look for dividend stocks with dividend income plus price appreciation to beat bond returns. However we are more conservative in this component that we want evaluate if the dividends alone of the stock can exceed bond income.

  1. Current yield greater than 20 years treasury yield Note that during high inflation and high interest rate period, for example 20 years treasury has ~4% yield in early 2023, it is difficult to pass this check for majority of good quality dividend stocks.

  2. Cumulative dividend income in 5 years is greater than income of 20 years treasury income Even the first check doesn’t pass, you could still end up with higher income in 5 years. This assumes that the dividend stock has no price appreciation (thus excludes the growth part of the total return), dividends still growing year over year, and 20 years yield stay flat for the next 5 years.



Dividend Safety Component

This component contains two checks. Passing either one earns half star. You want to make sure the company has the reasonable financial ratios that can sustain the current dividend yield and keep increasing it for years to come.

  1. Debt to total capital ≤ 45% This evaluates the risk of dividend being cut. 45% is a conservative threshold, many stocks can still pay dividends when debt ratio is over 80% but we want stocks with the best financial health.

  2. FCF has to be all positive in the past 7 years and current FCF payout ratio ≤ 60% Dividends are cash coming out of generated cash flow from business. You want to make sure the company have had enough positive cash flow to pay for the current dividend and leave room for future increase. 60% is a conservative threshold - a very mature company can healthily pay out 80%-90% of its cash flow at end phase. We want stocks way before the very mature phase and in the case the underlying business doesn’t do well, there is still space to do modest payout increase.



Profitability Component

This component contains two checks. Passing either one earns half star. Good dividend paying stocks need to have profitable business to keep the financial ratios described in last component. Here we apply two checks that Warren Buffet likes most to evaluate the profitability of a business.

  1. Both Average 5 years ROE and Last 12months ROE ≥ 15% ROE (Return-on-Equity) is the important ratio indicating how many profits can be generated with every $1 invested in the equity. Over 15% means the company is being managed and run with great efficiency.

  2. Last 12 months net income profit margin ≥ 10% Profit margin reflects how competitive the company is within its industry. Over 10% means the company’s products or services have certain moats and not easily substituted by competitions.



Fair Value Components

This component contains three checks. Only the last check affects rating and the other two checks are for your reference. We have developed a proprietary model to compute a composite fair value for each stock. If the current stock price is below the fair value, earn a full star.

  1. Stock share price is below the 5 years average high yield priceThe average high yield price is computed as the current dividend divided by the average high yield of the past 5 years.

  2. Stock share price is below the 5 years average P/E price The average P/E price is computed as the current net income times the average 5 years P/E ratio.

  3. Stock share price is below our proprietary fair value price The fair value price is a combination of the two reference prices mentioned in the previous two checks and deeper analysis from the other four components. The lower the share price is below the fair value price, the greater a buy it is.