I’ve heard it said many times that you need to have the right tool for the right job. When it come to analyzing investments there are many tools that are available to help us assess the merits of an investment or set us off in the right direction.
Setting off in the right direction can mean a lot of things but I like to think of things in terms of where you begin analysis. In the income investing space investors often look at the yield of an investment as a starting point. Trouble is that comparing the yield without comparing other factors can lead to poor investment choices.
Investment analysis tools can make for interesting starting points. Tools like the PE ratio or PEG ratio are well known. My feeling was and is that a great place for an income investor to start analysis would be to score income equities based on their yield and their volatility verses the market-a higher yield with low volatility being generally desirable.
And so I introduced the “Weiler Dividend Anchor Score” in my acclaimed book: InSync Income, The must Read Guide to Investing for Income in Canada. The DA Score divides the yield by the Beta of the equity. (See InSync Income)Stocks with higher yields and lower volatility will score better. In the book I explain that under different market conditions it makes sense to adjust the proportion of higher and lower scoring equities.
The DA Score was the focus of a recent Globe & Mail article by Rob Carrick titled: Anchor Your Dividend Expectations.
I recently conducted a research study in collaboration with Hamdi Driss, a member of PHD Research (Finance) at York University’s Schulich School of Business. Schulich was named #1 business school in Canada and in the top ten business schools in the world- Economist Global MBA ranking(2010) The study: The Weiler Dividend Anchor Score, Exploring the usefulness of the DA score as a security analysis tool, features research of oil & gas stocks on the Toronto Stock Exchange.
The goal of the study was to assess the usefulness of the tool by examining if companies with higher DA scores had, among other factors, fewer significant dividend reductions.
This was indeed the case with 57% fewer companies in the top quartile having significant dividend reductions of more than 30%. As would be expected, stocks in the highest quartile of DA scores also displayed the highest dividend yields and lowest volatility. Interesting to say the least.
And so the DA score may be an excellent vantage point from which to begin the analysis on income producing equities. This may be true but as with any ratio or starting point there is still much to learn about an investment before making a decision. Also, any decisions should be made in light of an overall portfolio strategy. In my book I cover how to create an “InSync Income Portfolio”.
Any security analysis tool will only take into consideration what it takes into consideration. So the Price Earnings or PE ratio will take into consideration the price and the earnings. The Dividend Anchor score takes into consideration the yield and the volatility versus the market.
This leaves a lot of room for additional analysis. I am currently working on a new tool that if useful and different enough to release will be named the “Enhanced Dividend Anchor Score” or EDA score. This score, if released, will take even more information into consideration. There is a trade off in making security analysis tools more complex since they then can begin to use their appeal as a simple tool –they become hard to use when too complex. I will consider all aspects before making a decision to release the EDA Score. Stay tuned.
Security analysis tools are not a substitute for the advice of a financial professional. My recommendation is to seek out the advice of a financial professional prior to making any changes to and existing strategy or implementing a new one. Invest with advice for best results.
The Income Investor’s Advocate