Active Portfolio Management Using Dividend Growth Stocks: The Role Of Technical Analysis

This guest contribution series is by Trond K. Odegaard, MBA; CEO at VikingDividendIncome LLC.

We begin this installment with a brief word about fundamental analysis. Fundamental analysis plays a crucial role in two ways.

Firstly, it is used to screen for and rank stocks that are expected to pay dividends with no cuts. There’s never a guarantee, but one does what one can to establish high confidence. Going back to our horse analogy from Part 1 of this series, this aspect of fundamental analysis helps us fill up the stable with good strong horses.

Secondly, fundamental analysis identifies (and quantifies) those stocks that are likely to be undervalued from a long-term perspective – 5 years or so.  This is a first step in identifying horses that are rested and ready to ride.

We determine the fair value Price/Cash Flow multiple of an individual stock considering its history and its competitors, with adjustment as seems appropriate based on considerations of future prospects.  Then, we project the cash flow (per share) expected out to year five, again considering its history and making adjustments as appropriate.  Multiplying these two factors together gives an estimate for the price of the stock, 5 years out.  There are more sophisticated (and complicated) ways to estimate future value (e.g., discounted cash flow), but this method works pretty well as a rough guide.  Once we’ve done all this, and presuming the stock’s dividend looks safe and it has a meaningful positive expected price return, what’s next?  Technical analysis.

The Role of Technical Analysis

Technical analysis is used to assess whether a stock is cheap or rich.  It’s the second step in determining whether the horse is rested and ready to ride.  It’s rather like checking that the saddle is tightly cinched and the bit is securely in the horse’s mouth.  You want to do both before you hop on for a ride.

Now, the first essential of active management, where it begins, is getting a good entry point.  Getting a good entry is certainly important in a buy-and-hold portfolio, but it’s crucial to active management.

There are a number of ways to do technical analysis.  Some analysts use the Elliot Wave approach, others look for patterns in the candles (e.g., head and shoulders, bull pennant).  Each method can add value when used by an experienced practitioner.  Elliot Wave has the disadvantage that it’s complicated to do and requires considerable effort to maintain.  Chart patterns have the disadvantage that there’s no quantitative component to the analysis – it’s entirely visual.

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