Financial data can help us paint a picture of the story of a company. In order to know that a company succeeded during a certain time period, we don’t have to be plugged into that industry or even be alive at that time to know the company did well. All it takes is a cursory look at the financials that were released.
Because our research is focused on companies in the stock market, the information we seek is freely available online. For official annual reports, sec.gov archives those all the way back to around 1994~1995. For widely used numbers such as net earnings, Wolfram Alpha allows us to search that data back to about 1982~1987.
The bottom line is that we can use tools freely available on the Web today to study a company’s financials and determine when a company did well. My free investing for beginners guide shows you how to do that.
However, it’s one thing to look back at the past and see it for what it is. The numbers paint the picture, and we can take the time to read them, but that doesn’t make them useful.
In fact, randomly picking successful stock winners and looking at their pasts can lead us into survivorship bias, where our data becomes skewed because we are ignoring the stocks that didn’t do well and only focusing on stocks that did do well.
But we can take a group of stock winners and use their data to see if any common characteristics arise. I did this when researching the biggest bankruptcies of the 21st century and found that negative net earnings was the most common characteristic of a stock about to go bankrupt.
Top dividend stocks research
Today I want to examine the other side of the spectrum, stocks that perform exceptionally well. For this list, I wanted to study stocks that had returned over 12% a year for a long period of time and also paid a dividend.
I found an article written by Sure Dividend that comprises of this exactly. The dividend stocks from this list are all now in the Standard & Poor's 500 and were among the best on a return-earned-to-shareholders basis over the past 25 years.
In fact, every one of these 15 top dividend stocks returned an average of 16% or more over this 25-year time period.
The financials I am interested in were derived before these great runs of success. Since the data are available for these companies spanning more than 25 years, we can examine the data as investors back then would’ve seen them.
If we can see what a company’s financials looked like before 25 years of superior stock performance, maybe we can take that data and apply them to new stocks we are looking to buy.
Here’s what the data tell us.
Context: Each financial ratio is taken from the last available 10-K report online. Then Wolfram Alpha was used to find net earnings numbers 10 years before that.
To calculate the 10-year earnings growth average per year, I took the three-year average from each data point. For example: the three-year average of earnings from 1994-1996 and 1984-1986.
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Perhaps not surprisingly, it’s important to note that every stock on this list had positive net earnings. This is in contrast to the 30 biggest bankruptcies in which the most common characteristic was negative earnings.
For almost every major financial ratio, there was a wide range of values from these 15 companies. You can’t take just one favorable ratio and use that to find winners; there’s no magic pill.
The sweet spot on a market capitalization basis for these companies was between $900 million and $21 billion. Most of the stocks were on a small cap basis around the $2 billion range.
Research has shown that the small cap index tends to outperform a large cap index and this seems to confirm it. Logically this makes sense because a high-performing stock with a small market capitalization has more room to grow and less chance for saturation.
About 50% of stocks had a price-book (P/B) value below 3, and half were above; 75% of the stocks had a price-sales (P/S) below 3. This is somewhat consistent with the findings from "What Works on Wall Street," which claims that a low P/B combined with a low P/S led to the best returns.
Screening every stock in the major indices with a P/B and P/S below 3 narrows a list of 7,000 down to 2,000 which is a start but isn’t by itself a major indicator of success.
Looking at other price-based valuations, we see that 75% of the stocks on this list had a price-earnings (P/E) at 25 or lower. This is great proof that you don’t have to overpay for earnings growth. We’ll talk more about growth in a minute.
For price to cash (P/C) about half of the stocks were around the 10 or 20 range and below. Interestingly, 80% of the stocks on this list had a debt to equity less than 2. This also confirms the bankruptcy research I did, where I found that the higher a stock’s debt to equity, the more likely the company was to fail.
Note the high debt to equity for Charles Schwab (SCHW, Financial) at 15. This is a common characteristic of financial stocks like banks or insurance companies. There are financial stocks with regular debt to equity levels, but that’s a topic for another time.
Though many high-growing stocks find success fueled by high amounts of leverage, you can see that it’s not necessary at all. In fact, it just adds another risk factor to an investment. There are plenty of great stocks that don’t come saddled with high debt.
Before I reveal the final and most telling result of this research, we must look at dividends. Many of the stocks on this list were 10-year consecutive dividend increasers at one point, and some still are. But even though these stocks were able to record double-digit returns for decades, only four out of 15 had 10-plus years of dividend increases already.
Frankly, I’m surprised that these companies found so much success yet some still had problems raising their dividends in various years. We clearly can’t just use past dividend success to predict future performance.
The most common characteristic
By far the biggest finding from all of this was the resounding success of these companies to grow earnings over long periods of time.
In fact a full 12, possibly 13, stocks of the 15 had at least 16% average yearly earnings growth over a 10-year time period. (Because of the Dollar Tree [DLTR] and Family Dollar [FDO] acquisitions, Family Dollar doesn’t have 10-year net earnings numbers available online. It’s possible that those earnings also averaged more than 16% per year.)
It’s obvious from these results that a track record of fantastic earnings performance is commonly associated with these winning stocks. Most of these stocks had these great earnings results for up to 10 years prior to going on mega 25-year sprees of shareholder compounding. That’s incredibly inspiring for prospective investors.
Combining all financials into one big picture shows us it’s possible to get the low valuations, low debt levels and high earnings growth numbers that we seek in stock buys.
For the Value Trap Indicator, a system with the main focus of avoiding high risk stocks with similar red flags to bankrupt companies, a full 25% of the stocks scored in the Strong Buy range. Many of the stocks flirted closely with this range, and it’s quite possible they crossed this point at a time of lower valuations.
Consider that the Value Trap Indicator was 96% effective in avoiding buying one of the 25 biggest bankruptcy stocks of the last couple of decades. You can see that with a 25% coverage of these highly successful dividend stocks, you can still purchase a stock very conservatively from a risk standpoint and produce outstanding returns in the process.
It’s a low risk, high reward endeavor.
Disclosure: The author doesn't hold any of the securities listed.
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