Wednesday, December 25, 2019

The DVK Quality Scoring System

David Van Knapp [DVK] presented an elegant and effective quality scoring system in this article on high-quality, high-yield dividend growth [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 quality scoring system as the primary way I assess the quality of DG stocks. While there are other factors I consider when selecting stocks for possible investment, I love the simplicity of this system. It does a remarkable job identifying high-quality stocks!


The goal of this article is to provide a summary of the quality scoring system and to document my modifications, which are minor but important for assessing the quality of a wide variety of DG stocks. Furthermore, I often write articles in which I rank DG stocks. This article explains how I modified the system to rank DG stocks by quality score.

Summary of the Quality Scoring System and My Modifications


The quality scoring system developed by David Van Knapp (henceforth, the DVK Quality Scoring 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 DVK Quality Scoring System and my modifications:

 Points  Value Line  
 Safety Rank 
 Value Line 
 Financial Strength 
 Morningstar 
 Economic Moat 
 S&P  
 Credit Ratings 
 Simply Safe Dividends 
 Dividend Safety Score 
51A++WideAAA
AA+ • AA • AA–&
81-100
(Very Safe)
42A+NarrowA+ • A • A–61-80
(Safe)
33A BBB+ • BBB • BBB–
No debt*
41-60
(Borderline Safe)
24B++ • B+Debt < 5%*21-40
(Unsafe)
1BDebt < 10%*
05< BNone< BBB levels0-20
(Very Unsafe)
A modified version of David Van Knapp's quality 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 None. The scoring system assigns 5 points for Wide moats and 4 points for Narrow moats, and no points otherwise.

For S&P credit ratings, points are only awarded for investment-grade stocks. In DVK's original system, a stock gets either 5, 4, 3, or 0 depending on its credit rating, or 0 if it doesn't have a credit rating.

Unfortunately, many stocks do not have credit ratings, including stocks with no or little debt. I think assigning 0 points to stocks with no or little debt penalizes such stocks excessively.

For this reason, I modified the scoring system to assigns 3 points to stocks with no debt, 2 points to stocks with debt of at most 5%, and 1 point to stocks with debt in the range 5-10%.

Finally, I use a similar color-coding scheme than in the original article, though I highlight stocks with perfect scores by putting them in a separate category.

 Quality Score  Note 
25 Stocks with Perfect Scores 
20-24Highest Quality Stocks
15-19High-Quality Stocks
10-14 Medium-Quality Stocks
5-9Low-Quality Stocks
0-4Lowest Quality Stocks

Ranking DG Stocks by Quality Scores


In order to rank DG 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 Scoring System is an elegant and effective quality scoring system presented by David Van Knapp and modified by the author of this article to allow assessing the quality and ranking of a wide variety of DG stocks.

Thanks for reading and happy investing!

Articles Featuring the DVK Quality Scoring System:

 Points  Value Line  
 Safety Rank 
 Value Line 
 Financial Strength 
 Morningstar 
 Economic Moat 
 S&P  
 Credit Rating 
 Simply Safe Dividends 
 Dividend Safety Score 
   Quality Score  Note 
51A++WideAAA
AA+ • AA • AA–&
81-100
(Very Safe)
25Stocks with
Perfect Scores
42A+NarrowA+ • A • A–61-80
(Safe)
20-24Highest Quality
Stocks
33A BBB+ • BBB • BBB–
No debt*
41-60
(Borderline Safe)
15-19High-Quality
Stocks
24B++ • B+Debt < 5%*21-40
(Unsafe)
10-14 Medium-Quality 
Stocks
1BDebt < 10%*5-9Low-Quality
Stocks
05< BNone< BBB levels0-20
(Very Unsafe)
0-4Lowest Quality
Stocks
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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