Investors look at a variety of factors when selecting a firm
in which to put their money. There are financial statements and ratios too
numerous to count as well as prices, values, trends, expectations, actions, hints,
tips, and other variables.
After wading through Security Analysis, The Intelligent Investor, and Strategic Value Investing, I offer three items for consideration as a Dividend Farmer
exploring investment options: Asset value, earning power, and dividend record.
Asset Value
The question of asset value seems simple enough. What are
the assets held by a firm and what value do they possess? This begs the
question, how do you define an asset and who establishes its value? From my
perspective, assets are primarily physical in nature.
For instance, blue sky associated with a brand name, good
will, or intellectual property is more difficult to value than physical plant,
inventory, or available cash. The former are subjective and generally dependent
upon the expected revenue stream generated over an indeterminate period using a
discount value that may or may not be well grounded. The latter, however, appraise
for spot sale through many tried and true methods allowing investors to
establish a value range narrower than that of blue sky.
When assets are difficult to value and have a wide range of
possibilities, investors must include a larger margin of safety within their investment
analysis and decision-making. Investment risk mitigation is challenging when
valuations vary widely. Howard Marks, co-founder of Oaktree Capital Management said:
“The key to success is in avoiding losers, not in searching
for winners.”
Wide and subjective valuation ranges increase the odds of
selecting a loser and reducing the chances of long-term investment success.
Earning Power
Earning power is more than a firm’s earnings, which may be
fluid depending on accounting methods used and the period governing the
earnings snapshot. Earning power includes the moat concept espoused by Warrant Buffett
in which he looks for firms with strong market positions in industries having significant
barriers to competitive entry. In other words, near monopolies can be good to
own from an investment perspective since they offer pricing power as well as
potentially long periods of stable cash flow generation given a lack of
competitive pressure.
Earning power may be a function of management expertise, judgement,
and ethical behavior as well. However, like the blue-sky discussion above,
management skill can be difficult to assess without extensive study or
exposure. This becomes challenging if management is relatively new or geographically
distant.
Like good will, judging management skill is often a
subjective task. Consequently, I emphasize other earning power attributes when
I size up a possible investment. The more objective I make my decision process,
the more I can mitigate risk and follow Marks’ guidance about avoiding losers.
Dividend Record
I'll admit I focus more on the Dividend Record of
a firm than I do asset value and earning power, but don't do so to the excluding of the two. How long has the firm paid
dividends? What is the yield? Are the dividend payments growing? If so, for how
long?
I check out several metrics and other decision criteria when
I invest in a firm; most of which are related to asset value and earning power.
The Dividend
Farming Scorecards offer a quick look at factors to consider.
If several metrics are off the mark or a few are seriously
out of bounds, the dividend record takes a back seat. However, if they are
close, firms with a long history of dividend payments and growth have an
increased chance of selection. I view long records of dividend growth as an
aggregated proxy for granular asset valuation and earning power metrics. This
is because I believe it’s hard for firms to produce long-running, solid,
growing dividend payments if asset valuations and earnings power aren’t sound
and consistent.
Asset value, earning power, and dividend record are part of
what Ben Graham and subsequently Warren Buffett termed intrinsic value. Intrinsic
value is justified by facts rather than assumptions, theories, or trends. As a value
investor, I work to base decisions on objective facts as much as possible.
Avoiding subjectivity and emotional decision-making helps me manage
the investment risk and increase my probability of success.
The thoughts expressed here
are those of the author, who is not a financial professional. Opinions should
not be considered investment advice. They are presented for discussion and
information purposes only. For specific investment advice or assistance, please
contact a registered investment advisor, licensed broker, or other financial
professional.
