Hundreds of hours of research and testing have yielded us a selection of value investing strategies and criteria that we are proud to call our own. We will show you what criteria to put together to meet your investing needs.
Whether you are looking for companies that offer great value and a large margin of safety, or you are looking for high dividend yield or continual dividend growth, we explain all the criteria and show you how to implement the strategies for yourself.
What is a Value Investing Strategy
A value investing strategy is a method of investing based on finding stocks that are trading at a significant discount to the value the stock market places on the share price. Using discounted cash flow, future earnings, the margin of safety, and fair value in a stock screener enables you to find stocks selling at a discount.
7 Proven Value Investing & Income Strategies
- Fair Value & Margin of Safety Buffett Strategy – Low Risk
- Highest Dividend Yield Strategy – Risky
- High Dividend Yield + 3 Year Dividend Growth Strategy – Less Risky
- Value + Dividend Strategy – Safest
- Safe Dividends Strategy
- Long-Term Dividend Growth Strategy
- Dividend Aristocrats 10 Year Dividend Growth Strategy
Here we share our 7 favorite value & dividend income strategies you could adopt, choose the one and adapt it for your investing style.
All the examples and research into this article were performed using our favorite stock screener Stock Rover which won our Best Value Investing Stock Screener Comparison.
1. Fair Value & Margin of Safety Buffett Strategy – Low Risk
|Fair Value & Margin of Safety Buffett Strategy Screening Criteria|
*Exclusive to StockRover
Probably Buffett’s most important measure to decide whether to invest in a company the Margin of Safety is the percentage difference between a company’s Fair Value and its actual stock price. This metric is the single most significant valuation metric in our arsenal as it is the final output of detailed discounted cash flow analysis.
Fair Value Warren Buffett bases his Intrinsic Value / Fair Value calculations on future free cash flows. To explain, Buffett thinks cash is a company’s most important asset, so he tries to project how much future cash a business will generate and also discount it against inflation. This is called the Discounted Cashflow Method.
A Strong Earnings Per Share History & Growth Rate. It will come as no surprise that earnings per share (EPS) is a very important metric for Buffett and Wall Street. Buffett looks for companies with a consistent track record of earnings growth, particularly over a 5 to 10 year period.
A Consistently High Return on Equity. This is a profitability measure calculated as net income as a percentage of shareholders’ equity, also called ROE. A high ROE shows an effective use of investor’s money to grow the value of the business.
Return on Invested Capital (ROIC), quantifies how well a company generates cash flow relative to the capital it has invested in its business.
Is the Company Conservatively Financed? The solvency ratio is a measure of whether a company generates enough cash to stay solvent. It is calculated by summing net income and depreciation and dividing by current liabilities and long term debt. A value above 20% is considered good.
If a company cannot make a profit per share higher than the return of a safe asset like treasury bonds, then you should not invest in it. This is an easy calculation and we will use the Earnings Yield. Earnings Yield is the earnings per share for the most recent 12-month period divided by the current market price per share.
2. Highest Dividend Yield Strategy – Risky
|Highest Yield Dividend Screening Criteria|
The first thing someone new to income and dividend investing would do is to look for stocks with the highest dividend yield. Naturally, they will want to choose a company that will pay the most in dividends.
Using the criteria on the right will help you find those highest yielding stocks.
Ideally, you will choose companies that are worth at least $500 M in Market Capitalization, any lower is simply far too risky. Next, you will search for any stocks with a dividend yield of greater than 4%. In this example, I have also chosen to scan for companies with at least 3 years of dividend payouts. Finally a Payout Ratio of less than 90%.
This scan will show you a list of stocks looking like this, I have sorted the list on dividend yield.
It is important that you drill down and take a deeper look into any company you are thinking about investing in. Take a look at the highest dividend yield stock in this list. CTPZY is currently yielding 30% and is listed on the OTC Pink Sheets Market. This could be a great deal, but first, let’s take a closer look.
Now although we have scanned for Dividend Yield higher than 0% you can see that the dividends are in constant decline to match the dip in share price and the reduction in earnings. Also, I am not really comfortable with a payout ratio of 54.2%, this means it is paying out over 50% of its earnings in dividends, this is on the high side and not really sustainable.
Is that something you really want to invest in? Perhaps if on further investigation you find it has a bright future in a growing market.
3. High Dividend Yield + 3 Year Dividend Growth Strategy – Less Risky
|High Dividend Yield Stock Screening Criteria|
The most obvious first strategy to pursue is to look for companies with the highest dividend yield. If a company has a current dividend yield of 10% then should you expect 10% income from your investment for that year?
The answer is maybe.
10% is a very high yield and it could be because of a number of reasons. For example, the stock price may have recently dropped dramatically, which would mean the dividend yield looks a lot higher because dividend yield is the dividend payment per share dividend by the price per share.
So in addition to a high yield strategy, you need to be able to ensure the dividend can be paid in the future, so you would look for a payout ratio that is not too high, ideally less than 50, which is still somewhat high.
This yields a list of 127 stocks, let’s take a look at the two highest yielding stocks on the list and compare them. Which one would you rather invest in?
Screener Results – Enel Americas (Ticker: ENIA)
ENIA is the highest yield stock in the list with 7.2% per year and a payout ratio of 35.4%, which looks OK. In Stock Rover when you look at the Dividend Payments Trend on the right of the image, you can see the dividend are in continual decline. Also, if you look closely you can see the Buffett Margin of Safety (Exclusive to Stock Rover) is at zero. This means that the companies market capitalization (stock market valuation) is equal to is future discounted cashflow (see intrinsic value). So there is some risk here.
Screener Results – Brookfield Property (Ticker: BPR)
Second in the list is Brookfield Property, a Real Estate Investment Trust (REIT). High Dividend Yield & solid Dividend Growth now this is a company I like the look of. They have an excellent dividend yield of 7%, probably because the stock price has declined so much. Here you can see the relationship between stock price and dividend yield. The big difference between these two companies is that BPR has an excellent 10-year record of increasing dividend payments (see the right panel) and it has a huge margin of safety of 47%.
The problem with this stock is that if you had purchased it 2 years ago you would be down 30% on the stock price, but you would be up 14% on the dividend. That would be a net loss. However, you only lose money when you sell the stock, if you are in for the long-term and buying now then you can choose when to sell for an overall profit.
Which one would you invest in?
4. Value + Dividend Strategy – Safest
|Value + Dividend Strategy Screening Criteria|
Looking for value stocks in addition to stocks paying dividends is a great strategy, and the cornerstone of Warren Buffett and Ben Graham’s investing strategy. While you may buy stock in a company for the dividends, if the stock price is likely to go down within your holding period the dividends might not offset the loss, so looking for value stocks that pay a dividend. It’s like buying extra insurance and avoiding unnecessary risks.
In this strategy, you want to look for dividend-paying companies that are inexpensive by traditional measures such as low price to earnings, price to sales and price to book. These companies should still be growing sales and earnings.
If you select Stock Rover as your screener you will have access to an exclusive set of criteria based on the Warren Buffett value investing principles of Fair Value/Intrinsic Value and Margin of Safety.
So let’s take a look at the results of this screen.
Screener Results – Carnival (Ticker: CUK)
Here we take a look at the second-highest dividend yield in the stock screen results.
From the initial view (above) I can see that despite a terrible year for the stock price, earnings have continued to grow.
The dividend yield is 5.1% which is healthy. It has a 45% payout ratio which is reasonable.
It also has a nice looking margin of safety of 47%. So at this price of $39 per share, there is very little risk in the deal.
If you think this is a good stock you should drill into the financials. On the right, you can see the Stock Rover Ratings for Carnival.
Value Score – 83. The Stock Rover value score looks at EV / EBITDA, P/E, EPS Predictability, Price / Tangible Book, and Price / Sales. The Price / Tangible Book and Price / Sales values are compared within a sector whereas the other metrics are compared across all stocks with adequate data. The best companies score a 100 and the worst score a 0.
Growth Score – 90. The Stock Rover growth score looks at the 5 year history and also the forward estimates for EBITDA, Sales, and EPS growth to rank the best companies across all stocks with adequate data. The best companies score a 100 and the worst score a 0.
Quality Score – 91%. The Stock Rover quality score compares profitability and balance sheet metrics to find high-quality companies. Our computation includes ROIC, Net Margin, Gross Margin, Interest Coverage, and Debt / Equity ratio values. The best companies score a 100 and the worst score a 0.
So, this stock is looking like something I might invest in.
5. Safe Dividends Strategy
|Safe Dividends Screening Criteria|
If you want to ensure the dividends you are banking on are safe, then you should look for additional factors to help support the notion you will continue to receive dividends in the future.
Look for higher capitalized companies, preferably above $2 billion. Lowering your dividend yield expectations to greater than 1.5% will enable companies with sustainable dividends to appear in your scan. You might also want to drop your 1-year dividend change, 3 year and 5-year dividend average criteria to >0%. This ensures they are paying a dividend over the long term.
Also, make sure your stocks are floated on a major (well regulated) exchange like the LSE, DAX, NYSE or NASDAQ.
In addition, you may want to drop your payout ratio criteria to <50 to ensure that the company is not already paying out too much in relation to its earnings.
Finally, you will want to make sure that the company is experiencing sales growth above the dividend averages or growth. This is additional insurance so that you know sales are growing therefore there should not be an impact on dividends in the future.
6. Long-Term Dividend Growth Strategy
|Long-term Dividend Growth Screening Criteria|
For this, you will need a stock screener with a significantly large historical database of earnings and dividend payments, such as Stock Rover.
The criteria shown here is the calculation for a 10-year period [Y9 – Y1]. This would typically return a list of only 5% of the NYSE or NASDAQ listed stocks.
Some well know names meet these criteria today, such as IBM, Texas Instruments and Disney.
7. Dividend Aristocrats 10 Year Dividend Growth Strategy
|10 Year Dividend Growth Screening Criteria|
For this, you will need a stock screener with a significantly large historical database (at least 10 years) of earnings and dividend payments, such as Stock Rover.
The criteria shown here is the calculation for a 10-year period.
Dividend Growth Criteria Explanation:
- Dividend Yield > 1.5%. This is a simple filter designed to ensure only companies actually paying a dividend above 1.5% are listed. Anything less than 1.5% will not even payout in line with inflation.
- Dividend 1 Year Change > 8%. Here we want to see only companies who have increased dividends in the last fiscal year of over 8%.
- Dividend 3 Year Change > 8%. Next, we filter down to those companies that have at least an average increase of 8% over the last 3 years.
- Dividend 5 Year Change > 8%. Again, only those companies increasing dividends more than 8% over the last 5 years.
- Dividend 10 Year Change > 8%. You get the idea. 🙂
- Payout Ratio >10 < 40. The payout ratio is designed to ensure the company is making enough profits to continue to pay the dividends and sustain the increases. You can reduce the “<10” to see more stocks in the scan. We do not want to see companies paying more than 40% of their profits out in dividends, they do need to retain cash flow for future growth and capital investments.
- Sales 5 Year Average (%) > 4%. This is designed to ensure that the company is indeed increasing sales at least on average to pay for the above growth in dividends.
- Margin of Safety > 0. (Exclusive to Stock Rover) For me the most important criterion of all, the Margin of Safety, using Warren Buffett‘s calculation, the forward discounted cash flow (see our article on Intrinsic Value). Essentially, the higher the margin of safety the more of a discount you are buying a stock for.
These criteria would typically return a list of only 5% of the NYSE or NASDAQ listed stocks.
Did you like these strategies? Let us know in the comments below.