The Volatility of Q-Scores

We first came up with Q-Scores because we wanted on objective way to measure the potential of a dividend growth stock to keep increasing our dividends over time. We calculated a Q-Score for every stock in our universe, analyzed each industry independently, and then assembled a portfolio of 30 dividend growth stocks. Now that our Quantigence DGI Portfolio is complete, we’ll continue to build our positions over the next few years to hit our target portfolio size of $400,000 putting off a yield of 3% which gives us $1,000 a month in passive income.

Now when we developed Q-Scores, we wanted to make sure it changed very slowly over time so that we could use it to spot trends. Is a stock’s Q-Score getting better or worse over time? In other words, we want to make sure that Q-Scores demonstrate low volatility over time. Let’s take a closer look at how volatile each of our data points is that comprise a Q-Score.

Years Dividend Increased: For every stock in our universe, this number will increase every year. If it doesn’t, that would mean we’re not holding that stock anymore and it is no longer part of our universe. LOW VOLATILITY

International Sales: Unless there is a major corporate event and the company’s business changes entirely, you won’t see this attribute move much at all over time. We’ll look to refresh the data points here at least once per year. LOW VOLATILITY

Market Cap: This factor won’t move very quickly unless we see a very large share price movement in a single month. Let’s say a 200 billion market cap company had a 25% share price increase in one month’s time. This would increase the Q-Score by 100 basis points but that would also be offset by a reduction in the Q-Score due to the smaller resulting yield (unless the dividend grew of course). MED VOLATILITY

5-Year Dividend Growth Rate: Let’s say you had a 10% 5-year dividend growth rate which suddenly had a year where dividend growth was just 1%. This would change your 5-year dividend growth rate to 8.2% and reduce your Q-Score by 46 basis points. That’s a pretty drastic event so we’d expect a meaningful effect on the Q-Score. MED VOLATILITY

10-Year Dividend Growth Rate: This attribute changes much slower than the 5-year growth rate as you would expect. Same as in our previous example, if a company had a 10-year average dividend growth rate of 10% and then one year paid just 1%, our Q-Score would decrease by only 20 basis points. LOW VOLATILITY

Yield: This is the most volatile of all 7 attributes because with yields of less than 1.5% a company will incur a penalty of -10 basis points for every 10% the yield falls under 1.5%. For example, if a stock has a yield of 1.6%, it receives a reward of 110 basis points according to our methodology. If the yield drops to 1.4%, the reward changes to a penalty of -10 basis points. This means that we can very easily see a net change of 120 basis points for a stock in a single month when yields cross the 1.5% threshold moving in either direction. HIGH VOLATILITY

Payout Ratio: While it’s not typical, companies can have payout ratios that fluctuate drastically, even though most companies will have a payout ratio they target and stick to. A good example of an entire industry having abnormally high payout ratios at the moment would be the oil industry which is not surprising. Using Chevron as an example, we’re currently penalizing them 100 basis points because they have a payout ratio that exceeds 95%. If CVX were to drop their payout ratio to a more manageable 75%, they would lose their 100 basis point penalty and receive a 100 basis point reward instead. This would represent a net change of 200 basis points. We believe that companies with volatile or consistently high payout ratios should be penalized because that is a leading indicator that shows future dividend raises are being threatened. HIGH VOLATILITY

In our next article, we take a look at a refresh of our dataset and how it impacts the Q-Scores of the 30 stocks we’re holding in our portfolio.

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