Today’s article comes from Jonathan Weber of Sure Dividend. Sure Dividend has been a great partner with us for years. I’m just now starting to get into dividend investing and I’ll be looking to implementing a lot of their insight. I had never heard of the chowder rule before, so I suspect that many of you haven’t either.
Many investors want to invest in stocks that offer income, especially retirees and other that live off the dividends they receive. Others prefer to invest in income stocks for the ability to reinvest cash flow consistently, even during market downturns.
No matter why one invests in income stocks, one way to evaluate potential picks is the so-called “The Chowder Rule“. The framework can be summarized like this:
The Chowder Rule is a rule-based system used to identify dividend growth stocks with strong total return potential by combining dividend yield and dividend growth.
It states that stocks are attractive when they offer a good combination of dividend yield and dividend growth — it does not make sense to look at only one of these. A 5% yield with no or negative growth isn’t particularly attractive, and neither is a company that grows its dividend reliably but that offers a yield of just 0.5%. The right combination makes for an attractive dividend growth investment, however. The Chowder Number is calculated by adding the stock’s current yield and its 5-year dividend growth rate.
The three rules popularized by Chowder that can be used when the Chowder Number has been calculated look like this:
Rule 1: If a stock has a dividend yield greater than 3%, its Chowder Number must be greater than 12%.
Rule 2: If a stock has a dividend yield of less than 3%, its Chowder Number must be greater than 15%.
Rule 3: If a stock is a utility, its 5-year dividend growth rate plus its dividend yield must be greater than 8%.
Some use the 5-year trailing dividend growth rate for the calculation, but we prefer to use the (expected/forecasted) 5-year forward dividend growth rate. After all, a company that has raised the payout considerably by expanding the payout ratio without growing its earnings and cash flows will most likely not continue to grow the dividend at the same pace. We thus believe that looking at expected earnings or cash flow growth paints a more realistic picture about a company’s long-term dividend growth potential.
Using this framework, we have identified three companies that look like attractive dividend growth investments according to the Chowder Rules.
1: Baker Hughes Corporation
Baker Hughes Corporation (BKH) is an oilfield services and equipment company that also is active in some other, less important areas, such as digital solutions for monitoring the health of machinery, etc. Its main businesses are oil and gas exploration, drilling, production, and other energy-related services.
Like oil and gas companies, its business outlook depends on the macro environment. High oil and gas prices mean that energy companies are inclined to expand production, which means that companies such as Baker Hughes get more orders and contracts and have the ability to grow their revenue and profit. On the other hand, Baker Hughes’ services will be in less demand when oil and gas prices are low and energy companies are cutting their exploration budgets.
Luckily, the macro environment is very beneficial for Baker Hughes right now, as energy companies are very profitable, and since the ongoing global energy crisis means that the production of hydrocarbons needs to be expanded. That’s why the growth outlook for Baker Hughes over the coming years is excellent. We believe that the company has the ability to grow its earnings-per-share at a mid-teens rate going forward, which should allow the company to grow its dividend at a similar pace.
Since Baker Hughes is currently trading with a dividend yield of 3.1%, its Chowder Number is somewhere in the 18% range — which is pretty attractive.
2: National Storage Affiliates Trust
National Storage Affiliates Trust (NSA) is a real estate investment trust that primarily owns self-storage properties in metropolitan areas throughout the United States. With around 800 such properties, National Storage Affiliates Trust is one of the largest players in this space.
Demand for self-storage space has been growing for many years, and so far, that trend has not broken. As consumers have been expanding their purchases of all kinds of material goods for many years, it seems likely that this trend will hold, and that consumers will continue to own more and more “stuff”. This stuff needs to be stored, and that’s where NSA and its peers come in.
The real asset nature of its business model also provides solid inflation protection, as property values and rents are increasing meaningfully in a high-inflation world, while debt gets inflated away over time.
Between rent increases for existing properties and acquisitions, NSA has delivered highly compelling growth in the past, roughly doubling its funds from operations-per-share between 2017 and 2021, i.e. in just four years. We believe that growth will slow down somewhat, but FFO-per-share growth should remain north of 10%, we assume. When that is combined with a dividend yield of 5.0%, the Chowder Number is in the 15 range, making for an attractive dividend growth pick.
3: ASML Holding NV
ASML Holding NV (ASML) is an industrial company that manufactures so-called lithography machines that are used to produce chips. It is the absolute market leader in this space, both from a market share perspective as well as when it comes to technological leadership. The Dutch company just has no competitor that is able to produce lithography machines that are as advanced as those from ASML.
The semiconductor industry has experienced rapid growth over the last decade, and growth should also be attractive going forward. Although there will be some ups and downs in the short run, megatrends such as digitalization, autonomous driving, virtual and augmented reality, and many more will lead to increases in both the number and the power of chips going forward. The industry should thus continue to expand, and chip manufacturers will continue to buy the lithography machines they need from ASML.
ASML thus has a compelling long-term growth outlook when it comes to revenues and profits. Its yield isn’t overly high today, at 1.7% (based on the payout over the last twelve months), but that’s at least slightly north of the broad market’s dividend yield. The dividend has grown at a rate of 32% over the last five years.
We believe that dividend growth will slow down going forward, but a mid-to-high-teens dividend growth rate seems very achievable based on the lowish dividend payout ratio of around 30% and when we consider the strong earnings growth outlook. We thus estimate ASML’s Chowder Number at around 18, making it a compelling dividend growth pick.
Thanks for the quality investment advice.