The Ramey Stock Rating is a tool that I have developed to help identify potential companies that are ripe for potential investment. It is a valuation metric that helps me to figure out whether or not a company might be an interesting buy.
The Ramey Stock Rating runs on a scale from 0-55 points. I personally consider any company with a stock rating above 38 to be a potentially good buy though I will occasionally buy into lower ratings as well. This is because the companies with lower stock ratings might be more solid companies and therefore more secure, it’s just that their valuation is not at a level where it is very enticing.
The stock rating currently consists of formulas based on four metrics, which are described below.
The Sweet Spot: 2.6-7%
The first metric that I utilize is the dividend yield on a stock. I personally target any yield 3% or higher, though I’m cautious of going much above 6 or 7%.
This is because as a rule of thumb, the higher the yield, the riskier the stock happens to be. This is usually because the market is pricing in risk by reducing the stock’s overall price, which drives up the dividend yield.
So as an investor, I am cautious not to “chase yield” and buy a stock that cannot support its dividend. This means that I like to target companies in a certain dividend yield range. If I see anything above 6%, I typically take a very cautious approach towards investing, unless it is driven by general negative market sentiment by Mr. Market.
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The Sweet Spot: 8-15x
The second criterion that I use is the PE Ratio. I tend to avoid companies that are overvalued, thus I tend to stay away from investing in companies with a higher PE ratio.
Instead I like to focus in on companies that have a lower PE ratio, which shows me that the market might be discounting the company’s earning power.
Keep in mind though that the PE ratio is not the end-all-be-all of earnings metrics. It’s only a small piece of the proverbial investing puzzle.
I will sometimes buy into companies with a higher PE Ratio, especially if I’m looking to park my excess cash into companies that tend to maintain a steadier value like $MSFT, $AAPL, etc.
Years Paying a Dividend
The Sweet Spot: 50+ years of dividend payments
This is probably one of the more important metrics that I use for buying stocks. While I will buy into companies that have not paid dividends for as long as the Dividend Aristocrats and Dividend Kings, I know that when doing so I am taking more risk in terms of the dividend payment being sustained.
As a dividend investor, nothing is more important than the dividend payment. Thus if we see that the dividend is cut or eliminated, our strategy essentially goes by the wayside. Sure we still own great companies, but our source of passive income has been eliminated.
This is why I like to see companies that have managed to sustain and grow their dividend payment through both the good and bad years. Companies that have the staying power to not only cash flow through selling great products but also return a steady dividend to reward me for being a shareholder of the company.
The Sweet Spot: 0-25% of income used for dividend payments
Another great metric to use is the dividend payout ratio. This is very important because if the payout ratio begins to climb as a percentage of net income, there could be risk that the dividend is approaching unsustainable territory.
Personally, I like to gauge the dividend against cash flow. To me, this shows the real metric as far as the sustainability of the dividend goes. If the dividend begins to make up a significant portion of cash flow from operations, then Houston, we have a problem.
I tend to view the payout ratio, which is calculated by taking dividends divided by net income, as a ‘canary in the coal mine’ of financial metrics. If the payout ratio begins to creep upwards towards too high of a level, you can be sure there is trouble ahead if the current trajectory remains in place.
Caveat: REITs are a different animal. Since their tax structure is set up to pay most of their net income back to the owners, it is not uncommon to see very high payout ratios when compared to normal operating companies.
For most companies though, the general rule of thumb is the lower the payout ratio, the better.
The Ramey Stock Rating Summary
There you have the ins and outs of the Ramey Stock Rating tool. You can find this rating utilized on our Dividend Stocks Watchlist, which is offered to the readers of MoneyByRamey.com.
While the formulas themselves remain proprietary, I did want to give you a little background so that you knew a bit more of what goes into making up the rating.
We’ll continue to build out and tweak the rating as the markets develop. As always, reach out to us with any questions, comments, or thoughts on any of the work we’re doing. We love to hear from our audience and patrons of the site!
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Disclosure: I am/We are long $AAPL $ADM $ALL $BG $BGS $BP $BUD $CALM $CAT $CLX $CMI $COF $CSCO $DAL $DFS $F $FAST $GD $GE $GT $HBI $IBM $INGR $INTC $IRM $JNJ $JPM $KHC $KMB $KO $KSS $LHX $LUMN $MMM $MSFT $NWL $O $PEP $PFE $PG $SBUX $SJM $SPTN $STX $SYY $T $TSN $UL $UPS $VZ $WFC $WPC $WRK $WY $XOM
Disclaimer: All the information above is not a recommendation for or against any investment vehicle or money management strategy. It should not be construed as advice and each individual that invests needs to take up any decision with the utmost care and diligence. Please seek the advice of a competent business professional before making any financial decision.
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