How to Score Compound Income↑ Stocks Part 2 - E&CF Cover

In this part i will briefly look at the security of income from dividend stocks which is quite commonly measured by the extent to which dividends are covered by earnings. This is probably conventional wisdom, quite sensible and there was research to back up why it is a good idea when selecting yield stocks provided by CSFB, which you can view by clicking on the link if that is of interest to you.

In addition, I combine this with the level of cover by free cash flow, again fairly obvious as the more free cash flow a company has the greater leeway or discretion they will have over maintaining or increasing the dividend and considering share buy backs or paying off debt.

Indeed share buy back and changes in debt levels are also worth noting as Mebane Faber has found in his research and book titled: Shareholder Yield: A Better Approach to Dividend Investing  that looking at total shareholder yield, including buy backs can be more productive than just selecting yield stocks. While Jack Vogel, who works with Wesley Gray the author of Quantitative Value, has come up with similar findings in his research looking at this but including buy backs and debt pay down in the calculation of shareholder yield. He also explored whether it was better using longer term data rather than one year data. You can read a summary of his findings at their useful site called Alpha Architect where you can also sign up for updates from them if that is of interest to you.

I don't screen for these factors (buy backs and change in debt) specifically, as I have not been able to find a way of easily tracking this for all stocks. However, using cash flow  does help to identify those companies that have the flexibility to provide a greater shareholder yield overall which is why I use it in my scoring of dividend cover. Since a score system is just a starting point for identifying attractive stocks, one can then go onto examine if the company is undertaking buybacks and paying down debt / building up cash when you do you further due diligence research.

In  Part 3 I will discuss how I go beyond the security of the dividend and what I use to monitor the strength of the balance sheet or the financial security of a company.