What Is the Chowder Rule?
What is the Chowder Rule? As financial blogger I am used to following rules, metrics, and ratios. The Rule of 72 is an important rule in investing. The 50/30/20 rule is important in budgeting. I also use my own personal rules and models for dividend growth investing. It is important to know when to buy a stock and when to sell a stock. For instance, I always sell a dividend stock when the dividend is cut or suspended. It’s a tough rule and should have made 2020 difficult for me. But I am always looking at dividend safety and I had one dividend cut in all of 2020.
When it comes to dividend growth investing, there is a rule that is very popular. It is called the Chowder Rule. The name comes from the nickname of a Seeking Alpha contributor and not the soup. The popularity of this rule is a result of its simplicity and the fact that it can be modified for your own personal use. You need only to add two numbers together and then compare it to some rules of thumb.
Definition of the Chowder Rule
The Chowder Rule is really quite simple. For a dividend growth stock, you take the current dividend yield and add it to the compounded annual growth rate (CAGR) for the dividend over the trailing 5-years. This gives you the Chowder Number, which is compared to one of three rules of thumb. Higher the Chowder Number the better.
Rules of Thumb for the Chowder Rule
Rule 1 – If 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 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%.
The rule for utilities is relaxed and thus the target Chowder Number is lower since utilities tend to have more predictable and stable earnings due to their regulated nature and local monopolies.
Goal of the Chowder Rule
The goal of the Chowder Rule is twofold. First, it is designed to differentiate between different types of dividend growth stocks. Do you pick a high yield stock but with low dividend growth or do you pick a low yield stock with a high dividend growth? For example, is it better to own AT&T (T) or Microsoft (MSFT)? I’ll discuss this more below.
The Chowder Rule is also designed to create a portfolio of stocks with a long-term CAGR of 8% or better, which is the second goal.
Example of the Chowder Rule
Earlier I asked the question of whether it is better to own AT&T or Microsoft in DGI portfolio. Let’s take a look at that now and include Apple (APPL), Lockheed Martin (LMT), and the utility South Jersey Industries (SJI) in the discussion as well. We will use data from Portfolio Insight*.
|AT&T||Microsoft||Apple||Lockheed Martin||South Jersey Industries|
|Forward Dividend Yield (%)||7.38%||0.76%||0.59%||2.76%||3.13%|
|5-Year Dividend Growth Rate||2.04%||10.13%||9.73%||9.77%||4.73%|
|Chowder Number (CDN)||9.42%||10.89%||10.32%||12.53%||7.86%|
|Check Against Rules||No <12%||No < 15%||No < 15%||No < 15%||No < 8%|
It is clear from this example that none of these five stocks currently passes the Chowder Rule. That being said, other valuation metrics may indicate that some of these stocks are undervalued. Additionally, you may want to buy a stock for other reasons besides dividend growth, such as income.
It is important to note that Chowder has indicated to use the Chowder Rule last. It is not a screening metric. You should first find high quality businesses and put them on your watch list if you are interested in buying those stock. The Chowder Rule comes into play when you are making decisions for buying stocks. What do I do? You know that I use my own internal models for screening and account for qualitative aspects. I don’t strictly use the Chowder Rule but I do look at dividend yield and 5-year dividend growth rate.
Risks for the Chowder Rule
There are risks in using the Chowder Rule and it is not foolproof. First, the 5-year dividend growth rate can be artificially inflated if there was a large increase from a small base. This often occurs when a company is in the early years of paying a dividend. Next, the 5-year dividend growth rate is based on past history and may not represent future growth rate. However, if earnings are rising then the dividend should grow as well. Another consideration is that the Chowder Rule does not consider payout ratio, dividend-to-FCF metrics or debt, which are measures of dividend safety.
Final Thoughts on What is the Chowder Rule
The Chowder Rule is forward looking in the it uses both dividend yield and dividend growth rate. These are both components of expected total annual return as defined and approximated by John Bogle. The third part of total annual return is expansion or contraction of the price-to-earnings ratio or valuation. The Chowder Rule is forward looking because the forward dividend yield and the dividend growth rate are based on expected earnings growth. The Chowder Rule also builds in a margin of safety by discounting by one-third from 12% to 8% or almost half from 15% to 8% in the case of most equities. Remember that the goal is 8% expected total return, which is pretty good over longer periods of time.
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Chart or Table of the Week
Today I highlight a screener tool from Stock Rover* focused on large cap growth with momentum that I modified for dividend yield and dividend growth. This screen looks at 11 criteria including 2-year return versus industry and the S&P 500 averages, 3-month return versus industry and S&P 500 averages, EPS growth 5-year average, market cap, operating income growth 5-year average, P/E ratio, sales growth 5-year average, dividend yield greater than 1%, and a dividend growth rate greater than the median. Only 6 stocks pass this list. Of these I own only T. Rowe Price (TROW), which is a Dividend Aristocrat. The screenshot below is from Stock Rover*.
Dividend Increases and Reinstatements
I have created a searchable list of dividend increases and reinstatements. I update this list weekly. You can search for your stocks by company name, ticker, and date.
Dividend Cuts and Suspensions List
I updated my dividend cuts and suspensions list at end of July 2021. The number of companies on the list has risen to 527. We are well over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic.
There is one new company to add to the list this past month. This company is Shell Midstream Energy Partners L.P. (MPLX).
Dow Jones Industrial Averages (DJIA): 35,516 (+0.87%)
NASDAQ: 14,823 (-0.09%)
S&P 500: 4,468 (+0.71%)
The S&P 500 is trading at a price-to-earnings ratio of 34.9X and the Schiller P/E Ratio is at about 38.8X. These two metrics up the past three weeks. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively.
I continue to believe that the market is overvalued at this point. I personally view anything over 30X as overvalued based on historical data. The S&P 500’s valuation came down as companies in the index reported solid earnings lapping a Q2 2020 that had depressed earnings.
S&P 500 PE Ratio History
Shiller PE Ratio History
Stock Market Volatility – CBOE VIX
The CBOE VIX measuring volatility was down over 0.5 points this past week to 15.45. The long-term average is approximately 19 to 20. The CBOE VIX measure of the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.
Fear & Greed Index
I also track the Fear & Greed Index. The index is now in Fear at a value of 43. This is up 7 points this past week.
There are seven indicators in the index. They are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.
Market Momentum is indicating Greed. The S&P 500 is 7.29% over its 125-day average. This is further above the average than normal over the past 2-years.
Safe Haven Demand is in Greed. Stocks have outperformed bonds by 3.06% over the past 20 trading days. This is still close to the strongest performance for stocks over the past 2-years as investors move back into bonds.
Junk Bond Demand is indicating Greed. Investors are accepting 2.00% yield over investment grade corporate bonds. The spread is down further from recent levels indicating that investors are taking on more risk.
Put and Call Options are signaling Neutral. In the last five trading days, put option volume has lagged call option volume by 56.04%. This is still amongst the highest level of put buying in the past two years.
Market Volatility is set at Neutral. The CBOE VIX reading of 15.45 is a neutral reading.
Stock Price Breadth is indicating Extreme Fear as declining volume is 2.17% more than advancing volume on the NYSE during the last month. This indicator is near the lower end of its range over the past two years.
Stock Price Strength is signaling Extreme Fear. The number of stocks hitting 52-week highs compared to those hitting 52-week lows is at the lower end of its range.
The U.S Bureau of Labor Statistics Job Openings and Labor Turnover Survey, or JOLTs reported a record 10.1 million job openings as of the last day of June, bettering an upwardly revised 9.5 million in May. The job openings rate rose to 6.5% and hires increased to 6.7M, up from 6.0M in May. Increases came in retail trade (+291,000), professional and business services (+123,000), state and local education (+94.000), and durable goods manufacturing (+36,000). Decreases came in arts, entertainment, and recreation (-12,000) and information (-8,000). Payrolls increased by 943,000 in July — the most in nearly a year. A record-low 1.3M workers were laid off or fired in June.
The U.S. Bureau of Labor Statistics reported the consumer price index rose 0.5% in July; this follows a 0.9% increase in June. The index is up a seasonally adjusted 5.4% from a year ago. The indexes for shelter (+0.4%), food (+0.7%), energy (+1.6%), and new vehicles (+1.7%) all contributed to the increase. Used car and truck prices moderated in July at 0.2% increase, after a 10.5% boost in June and a 7.3% increase in May. Shelter, which makes up a third of the overall CPI is up 2.8% year over year. The energy index is up some 23.8% over the past 12 months. Transportation services reported a decline of 1.1% and follows a 1.5% increase the previous month. Core CPI, which excludes the more volatile food and energy costs, increased 0.3% in July and is up 4.3% year over year; this follows a 4.5% increase for the 1-year period ending in June.
The Labor Department reported slightly lower initial jobless claims for the week ending August 7th. The seasonally adjusted initial claims came in at 375,000, a decrease of 12,000 from the previous week’s upwardly revised level. The four-week moving average, which smooths out volatility was 396,250. Michigan (-4,365) posted the largest decline in initial claims last week, followed by Florida (-3,337) and Georgia (-3,254). California (+6,347) posted the largest increase, followed by Virginia (+4,793) and Maryland (+2,395).
Thanks for reading What is the Chowder Rule? – Week in Review!
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.