Use the Chowder Rule to Research and Buy Dividend Growth Stocks


If you are a dividend growth investor, the Chowder rule or Chowder principle is something you should know. The chowder rule is a great way to research dividend paying stocks as it concentrates on Total Return whilst aiming for a Margin of safety. Using this principle, dividend investors can create long-term compounded annual growth rates of over 8% with relatively low downside.

In the most basic of terms, 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.

The great thing about the Chowder Rule is that it is flexible. It is applied differently to different stocks. The criteria and rules are below:




Rule 1: If stock has a dividend yield greater than 3%, its 5-year dividend growth rate plus its dividend yield must be greater than 12%.
Rule 2: If a stock has a dividend yield less than 3%, its 5-year dividend growth rate plus its dividend yield 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%.

As mentioned above, the Chowder Rule applies both the Total Return and Margin of Safety principles to accomplish the goal of achieving 8% per annum compounded returns,

If a stock has a dividend yield of over 3% : a 50% margin of safety is used.
Instead of hoping everything goes smoothly with a stock with a projected Compound Annual Growth Rate (CAGR)of 8%, invest in stocks with a projected CAGR of 12% and give yourself a 50% margin of safety.

If a s stock has a dividend yield below 3% : a 87.5% margin of safety is used.
Instead of hoping everything goes smoothly with a stock with a projected CAGR of 8%, invest in stocks with a projected CAGR of 15% and give yourself a 87.5% margin of safety. The intuition behind this is that fast-growing stocks will likely have their growth slow at some point, so a high margin of safety is required.



If a stock has a dividend yield of over 3%: a 50% margin of safety is used.
This is because the required projected CAGR decreases to 12%. So as your dividend yield increases, you can see that your margin of safety reduces.

Stocks like Utilities and Telecoms which offer high yield but slower growth are treated differently under the Chowder. Due to their nature, huh regulation and high barriers of entry (low competition), the margin of safety principle is dis-applied under the Chowder Rule. When it comes to these types of stocks, you only need to look at the total return being over 7% for it to qualify.

That basically is the process of suing the Chowder Rule to pick Dividend Growth Stocks. So if a company pays a low dividend but has a high growth rate, the margin of safety is high. If the dividend increases to 3%, the margin of safety can be reduced. And if the stock pays a chunky dividend, the margin of safety can be ignored and you look at the total return.

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