The Chowder Rule & Your Stock Selection Process

Chowder RuleThe premise of dividend growth investing is not only finding a stock that can pay growing dividends but also offer stock appreciation for your portfolio over time. Chowder, as identified on Seeking Alpha, defined that approach as double dipping. I very much like the concept of double dipping and it has been the basis of my stock selection approach. It’s partly why I dropped the following blue chip stocks; AT&T NYSE:T and Manulife TSE:MFCNYSE:MFC . They simply failed to pass the Chowder Rule.

What makes the Chowder Rule perfect for my stock selection process is that it fits really well with how I use Dividend Achievers with a 10% CAGR dividend growth over a 10 year period. Another reason for liking the rule is that it is very simple in nature for anyone to understand. All you have to do is add 2 numbers together and then make a decision based on the investment goals you have.

Chowder Rule Explained

The Chowder Rule simply tries to identify a high growth dividend stock by adding the current dividend yield and the 5-year CAGR dividend growth. The rule is setup to surface the best total return dividend stock where you make money from dividend growth and stock appreciation. Below is the formula he outlined where High Quality Stock is for you to decide.

High Quality Stock + High Current Yield + High Growth of Yield = High Total Return.

It’s just that simple and it embodies the two stock investing concept below. He came up with the rule as a way to help him decide between buying a great company with a 1% dividend yield vs another great stock with 5% dividend yield and all the other yield in between. There is a desire to receive dividend income but not to the sacrifice of the total return (dividend income vs total return). The rule helps put the two together and it leverages the CAGR dividend growth to establish a company’s growth.

Dividend Yield Reflects Market Price By Investors

The rule takes into account the fact that if a stock performs well and is valued by investors, the dividend yield would stay relative and within a certain range. If the stock was to be overvalued, the dividend yield would go up as the price would drop and if it was undervalued, the price would tend to go up and the dividend yield would go down. It’s just how the stock market reacts to the performance of a company.

Dividend Growth Reflects the Company’s Profitability

Using the historical dividend growth of the company to identify the company’s profit, you can expect that consistent dividend growth implies the company has the ability to grow their bottom line and increase profit. You cannot increase the dividend consistently without the price of the stock (see previous point) taking a beating.

One caveat on the dividend growth is to ensure the dividend payout ratio is not growing at the same rate otherwise it’s a fake growth in bottom line.

Applying the Chowder Rule

Chowder established the following guidelines for himself but they are for you to adapt to your investing style. His initial thoughts based on his research was to target 3% dividend yield and 5% dividend growth for a total of 8%. He then adjusted it for the moat and settled with a total of 12%.

  • For a stock with 3% dividend yield, he needs 9% dividend growth. This is where the dividend yield and dividend growth can offset each other.
  • For certain stocks such as utility, he establishes a lower dividend growth of 5% for a total of 8% as a rule target

How I use the Chowder Rule

Once I applied the Chowder Rule to my dividend stock list (all 100+ stocks), I was not as happy with the results from the 5-year dividend growth rate identified by Chowder. Some stocks passed the rule without the consistency in dividend growth. I tried 10-year and got the same results as well as with the average of 3, 5 and 10-year dividend growth. I decided to use the lowest of the 3 data points I track and that worked well. The result of using the minimum value of the 3 CAGR data points is that it excludes any inconsistent spike in dividend growth and is a little more strict.

My intention is to blend my stock selection process by using the Chowder Rule on Dividend Achievers together. Keep in mind that the rule does not assess whether a stock is undervalued or not or if it’s a good company to invest in to start with. The High-Quality Stock part is for you to assess whereas the Chowder Rule tries to establish the potential for total growth.

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