Wednesday, December 25, 2019

DVK Quality Snapshots

David Van Knapp [DVK] presented an elegant and effective system to assess the quality of dividend growth [DG] stocks in this article on high-quality, high-yield DG stocks. The system employs five widely used quality indicators from independent sources and assigns 0-5 points to each quality indicator, for a maximum of 25 points.

I've adopted the system (called Quality Snapshots) as the primary way I assess the quality of dividend stocks. While there are other factors I consider when selecting stocks for possible investment, I love the simplicity of Quality Snapshots. It does a remarkable job identifying high-quality stocks!

Note that I use Quality Snapshots to asses the quality of both dividend stocks (stocks of companies that pay dividends) and DG stocks (stocks of companies that pay and regularly increase their dividends).

The goal of this article is to provide a summary of Quality Snapshots and to document my modifications, which are minor but important for assessing the quality of a wide variety of dividend stocks.

Furthermore, I often write articles in which I rank dividend stocks and this article explains how I modified the system to rank dividend stocks by quality score.

Summary of the Quality Snapshots scoring system


David Van Knapp developed Quality Snapshots as a quick way to assess the quality of DG stocks. The system employs five quality indicators and assigns 0-5 points to each quality indicator, for a maximum of 25 points.

Here are the quality indicators used in determining a stock's quality score:
Readers can learn more about these quality indicators by following the provided links.

VL's Safety Rank measures the total risk of a stock relative to approximately 1,700 other stocks covered by VL. The safest stocks are assigned a rank of 1, whereas the riskiest stocks are assigned a rank of 5.

VL also provides Financial Strength ratings, from A++ to C in nine steps. The lowest rating is reserved for companies in serious financial difficulty. Factors considered in assigning ratings include balance sheet strength, corporate performance, market capitalization, and stability of returns.

The next quality indicator is M*'s Economic Moat, a proprietary data point that reflects the strength and sustainability of a company's competitive advantage. A wide moat company is positioned to sustain economic profits for at least 20 years, whereas a narrow moat company can do so for at least 10 years.

S&P provides Credit Ratings to help investors determine investment risks. Ratings are either investment grade (AAA through BBB–) or speculative (BB+ through D).

The final quality indicator is the Dividend Safety Scores provided by SSD. Scores range from 0 to 100 and are based on more than a dozen fundamental metrics that influence the ability of companies to continue paying dividends:



Here is the scoring system used to compile Quality Snapshots:

 Points  Value Line  
 Safety Rank 
 Value Line 
 Financial Strength 
 Morningstar 
 Economic Moat 
 S&P  
 Credit Rating 
 Simply Safe Dividends 
 Dividend Safety Score 
51A++Wide MoatAAA
AA+ • AA • AA–
81-100
(Very Safe)
42A+ Narrow Moat A+ • A • A–61-80
(Safe)
33A  BBB+ • BBB • BBB– 
Debt/Capital < 10%
41-60
(Borderline Safe)
24B++ • B+No Moat21-40
(Unsafe)
1B
05< B< BBB– levels0-20
(Very Unsafe)
  DVK's Quality Snapshots scoring system

Generally, 5 points are assigned to the highest ranks and best ratings, so the highest quality stocks would get 5 points on every factor for a maximum score of 25.

Some of the quality indicators do not map to every point in the scoring system.

For example, M*'s economic moat rating distinguishes between three kinds: Wide, Narrow, and No moats. The scoring system assigns 5 points for Wide, 4 points for Narrow, and 2 points for No moats. DVK does not penalize companies with No moats because "some companies can still succeed simply based on customer preferences".

For S&P credit ratings, points are only awarded for investment-grade stocks. A stock gets either 5, 4, 3, or 0 depending on its credit rating, or 0 if it doesn't have a credit rating. Some stocks do not have credit ratings, including stocks with no or little debt. In such cases, the scoring system assigns 3 points to stocks with Debt/Capital less than 10%.

DVK's Quality Snapshots ratings


DVK uses the following ratings to interpret quality scores:

   DVK's Quality Snapshots ratings

This is a more stringent interpretation of quality scores than DVK originally implied with the color-codes he used. He wants to own stock of "really good companies" that he doesn't have to worry about.

My Quality Snapshots ratings


I use a less stringent interpretation of quality scores, mainly because I often assess the quality of a wide range of dividend stocks. Having a more nuanced distinction between different stocks, especially in what DVK calls Speculative stocks, is important.

Here is the rating system that I now use for my own stocks and for articles I write:

 Score  Rating  Grade 
25 Exceptional  Investment
23-24Excellent
19-22Fine
15-18Decent
10-14Poor Speculative 
0-9Inferior
My Quality Snapshots ratings

I distinguish stocks with perfect scores from other excellent stocks and use other monikers for my ratings. Otherwise, my ratings pretty much map to the DVK's ratings.

Here are the meanings of the monikers I chose, as defined in the Macmillan Dictionary:
  • Exceptional — extremely good or impressive in a way that is unusual
  • Exceptional — extremely good
  • Fine — of very good quality
  • Decent — good, or good enough
  • Poor — used for saying that something is not as good as it should be
  • Inferior — if something is inferior, its quality is not good

Ranking DG Stocks 


In order to rank stocks I need a way to break ties, so I consider the following factors in turn:
  • SSD Dividend Safety Scores
  • S&P Credit Ratings
  • Dividend Yield
For example, at the time of this writing, Johnson & Johnson (JNJ) and Procter & Gamble (PG) both have perfect quality scores of 25. To break the tie, first I consider their dividend safety scores. Both have Very Safe scores of 99, so the next tie-breaker is used: the credit ratings. Here JNJ wins out because it is one of only two stocks with an AAA credit rating.

Concluding Remarks


The DVK Quality Snapshot scoring system provides an elegant and effective way to assess the quality of dividend stocks. I use the scoring system as presented by DVK, but I use my own rating and ranking systems to allow assessing the quality and ranking of a wide variety of dividend stocks.

Thanks for reading and happy investing!

Articles Featuring the DVK Quality Scoring System:

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2 comments :

  1. Isn't one of the downsides that most of the used metrics are some metrics/scores that require a paid subscription to e.g. Morningstar/Value Line? Do you know if these services also cover stocks from other markets, like Europe etc?

    Thanks,
    Daniel

    ReplyDelete
    Replies
    1. Yes, for some the paid subscriptions will be deemed a downside of this approach. I have a different opinion. The suppliers of of these metrics are independent. As David van Knapp says in linked article:

      "By "independent," I mean ratings from analysts who are not sell-side, and I exclude companies' characterizations of themselves. I'm interested in the opinions of outfits that sell information for a living; I believe that they have more incentive to try to be objective and avoid puffery."

      Furthermore, these suppliers are fairly comprehensive, with coverage of several hundred US-traded dividend growth stocks, the exact stocks that I'm interested in analyzing for my DivGro portfolio.

      Unfortunately, I'm unaware of similar comprehensive, independent sources for other markets.

      Delete

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