• The Chowder Rule Explained
• Adjusting the Chowder Rule
• Top Dividend Aristocrats Using the Chowder Rule

The Chowder Rule is a rule-based system used to identify dividend growth stocks with strong total return potential. The Chowder Rule was invented and popularized by Seeking Alpha contributor Chowder. The Chowder Rule is applied differently to different stocks. The criteria and rule are below:

• If stock has a dividend yield greater than 3%, its 5-year dividend growth rate plus its dividend yield must be greater than 12%.
• 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%.
• If a stock is a utility, its 5-year dividend growth rate plus its dividend yield must be greater than 8%.

Ideology

The ideology behind the Chowder Rule is straightforward.  The goal of the Chowder Rule is to create a long-term CAGR of over 8%.  For stocks with a dividend yield over 3%, a 50% ‘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 12% and give yourself a 50% margin of safety.

The margin of safety is expanded for fast-growing low-yield dividend stocks. If a stock has a dividend yield below 3%, the required projected CAGR is expanded from 12% to 15%. This gives you an 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 higher margin of safety is required.

Utility stocks typically have high yields and slow growth rates. They are highly regulated and typically enjoy regional competitive advantages from strong barriers to entry. As a result, the margin of safety on utiltiy stocks is removed using the Chowder Rule.  Utility stocks need only have an expected total return of 8% to pass the Chowder Rule

The Chowder Rule Is Just the First Step

Passing the Chowder Rule does not automatically qualify a stock for investment. Passing the Chowder Rule means that the stock is a candidate for investment.  Investors should make sure they are comfortable with the underlying businesses’ long-term competitive advantage.  Additionally, valuation should be considered .

Adjusting The Chowder Rule

The Chowder Rule makes intuitive sense. The only issue that I have with the Chowder Rule is how unreliable using the 5 year dividend growth rate is for projecting growth. The dividend growth rate subject to changes in the payout ratio. Take the following example:

• Stock sees EPS fall from $10.00 to $5.00 in 5 years
• Stock raises dividend from $1.00 per share to $3.00 per share in 5 years

Does the stock really have a fantastic 30%+ growth rate?  No; the underlying business is likely in decline, but the dividend growth rate shows tremendous growth. This is because the payout ratio has increased from 10% to 60% in 5 years. That is where the growth comes from.

If one used EPS, as in the example above, one could get a somewhat more accurate picture of growth. EPS numbers are fairly unreliable as well, however, because they are reliant on profit margins.  Profit margins are typically mean reverting over long periods of time and can unfairly skew (either up or down) a company’s real underlying business growth.

I prefer to use the lower of revenue per share or dividend per share growth over a 10 year period to quantify growth rate for most businesses.  For some financial businesses (banks, insurance), the lower of book value per share and dividend growth is used as an alternative.

Using the lower of dividend and revenue growth helps correct for companies that are seeing revenue surge by investing in unprofitable business prospects. If dividend growth is lower than revenue growth, a company is either not rewarding shareholders at the same rate as underlying business growth, or is taking on low-margin or unprofitable projects that are growing revenues but not creating real cash flows that can be paid out in dividends.

Altering the Chowder Rule’s growth metric will provide more accurate results without deviating from the spirit of the Chowder Rule.

Sure Dividend Stocks & The Chowder Rule

There are currently 146 stocks in the Sure Dividend database. Each stock has 25 or more years of dividend payments without a reduction. Only 6 stocks pass the adjusted Chowder Rule out of the 146 in the Sure Dividend database. Interestingly, no Dividend Aristocrats pass the test at this time.

Helmerich & Payne (HP)
Dividend Yield:  4.3%
Growth Rate:  13.7%
Chowder Rule Minimum:  12% because dividend yield is greater than 3%
Chowder Rule Score:  17.0%

BHP Billiton (BHP)
Dividend Yield:  5.4%
Growth Rate:  10.8%
Chowder Rule Minimum:  12% because dividend yield is greater than 3%
Chowder Rule Score:  16.2%

Phillip Morris (PM)
Dividend Yield:  4.8%
Growth Rate:  8.6%
Chowder Rule Minimum:  12% because dividend yield is greater than 3%
Chowder Rule Score:  13.4%

Enbridge (ENB)
Dividend Yield:  3.3%
Growth Rate:  11.6%
Chowder Rule Minimum:  12% because dividend yield is greater than 3%
Chowder Rule Score:  14.9%

United Health Group (UNH)
Dividend Yield:  1.4%
Growth Rate:  13.6%
Chowder Rule Minimum:  15% because dividend yield is less than 3%
Chowder Rule Score:  15.0%

American States Water (AWR)
Dividend Yield:  2.1%
Growth Rate:   6.5%
Chowder Rule Minimum:  8% because it is a utility
Chowder Rule Score:  8.6%

Ranking The Top 6 Chowder Rule Stocks

Of these 6 stocks, 5 are ranked in The Top 40 using The 8 Rules of Dividend Investing.  Only America States Water is not in the Top 40 using The 8 Rules of Dividend Investing. The Chowder Rule inclusion criteria for utilities is much more lenient than for other stocks. This explains why American States Water does not rank higher using The 8 Rules of Dividend Investing.

The 5 non-utility Chowder Rule stocks above offer investors strong total return potential.  In addition, all 25 stocks have long dividend histories which show their management has historically been shareholder friendly.

Final Thoughts

The Chowder Rule is a well-thought out method to find attractive dividend growth stock investments. One of the biggest drawbacks of the Chowder Rule is the inaccuracy of using 5 year dividend growth numbers. A longer growth look-back period combined with selecting better growth metrics will provide a better picture of Chowder Rule stocks.