Inspiration

The Chowder Rule in practice: applying it to my DGI portfolio

Chowder Rule

Chowder is a famous contributor on SeekingAlpha who introduced a new valuation metric focused on potential total return. The “Chowder Rule” became quickly very popular among dividend growth investors. The reason for that lies in its simplicity:

Take the current dividend yield and add the compounded annual growth rate (CAGR) for the dividend. This should equal at least 12% in most of the cases for it to be attractive (see recommended read for in-depth explanation).

Recommended read: 3 investment rules of thumb every investor should know

What I like about this rule is that it focuses on total return. As a dividend investor I would really like to get as quick as possible to a Yield on Cost of 10% so that I benefit as much as possible from the compounding effect. The chowder rule is therefore a perfect last step when you are considering to purchase a new dividend growth stock.

Hence, it serves its purpose as a valuation metric.

The Chowder rule applied to my current portfolio

And this is where the fun starts!

We had Dividend Wave on our Podcast last week and somehow we got to talk about the Chowder rule. He recommended me to try and map my whole portfolio on a graph to assess which companies are attractively valued right now.

I found this idea very interesting, because I had never done that before. What interests me in particular is to see which companies I should currently pay more attention to. Hence, I did this as an exercise to ask myself the following questions:

  • Are there companies in my portfolio which at current valuation provide me with both a solid yield and dividend growth?
  • Should I double down on them and grow my positions more rapidly?

Well, let’s check then. Let’s have a look at the below graph to see which companies provide an attractive value as per the Chowder Rule. I call this “the Chowder Zone”.

Dividend Growth Portfolio plotted according to the Chowder Rule
Dividend Growth Portfolio plotted according to the Chowder Rule

As you can see, according to this exercise AbbVie would be the absolute winner. The reason for this is their 5 year CAGR of 18.5% + a current dividend yield of 4.9% = 23.4. This is way above 12%.

In this case I’m not intending to add more shares to my position in AbbVie, because it’s already a full position. I will rather let this company do it’s job and further grow my wealth.

Another interesting observation is the position of Ahold Delhaize. I am very happy with my shares in Ahold and it has done me really well. This is evidenced by their latest FY2020 report in which they increased their full year dividend once again. This time from €0.76 to €0.90 per share on an annualized basis.

Doing this analysis and creating the below one-pager has convinced me to buy additional shares in Ahold Delhaize. Hence, I increased my position in Ahold when the share price hit €22.50 last Thursday.

Ahold Delhaize Q4 report
Ahold Delhaize reported their Q4 and Fiscal Year 2020 report

The last observation about companies in the Chowder zone is about Red Electrica and Enagas. These are both 2 Spanish utilities which pay a very high dividend yield right now. Their share prices are currently suppressed due to the unrest in politics in Spain. Investors seem to be afraid that the Spanish government will step in and create a negative investment case for them.

The high dividend yield is off course one element of the Chowder rule. The reason why they are in the Chowder zone is also their past 5 year dividend growth. This was 4.46% for Enagas and 5.56% for Red Electrica.

And this is also were the weakness of the Chowder rule kicks in.

Flaws of the Chowder Rule

The Chowder Rule is based on the 5 year CAGR which is a metric based on past performance. We know already from both Enagas and Red Electrica that their future dividend growth will be less. Hence, it’s unlikely that the total return based on dividend growth will end up above 12% in the upcoming 5 years for both these stocks.

Another weakness in the Chowder Rule is that it doesn’t take the payout ratio into account. A company can often show really high growth rates if it just recently started their dividend growth journey. A typical symptom is that the annual dividend growth outpaces the annual earnings per share growth. The result of that is an increasing payout ratio.

This is why it’s better to model your future 5 year CAGR in dividend growth taking your own outlook into account.

If you do this, then the Chowder Rule is really a clever rule as a litmus test before purchasing a stock and after you have done all your other homework.

Final Thoughts

This was a real fun exercise to analyze which companies in my portfolio are currently attractively valued. As you might have noticed, I haven’t really spoken about the companies which aren’t in the Chowder zone. There are around 30 companies in that space and it would be a bit too much to walk through all of them. However, if you have any specific questions about one of them, then feel free to ask me about it in the comment section.

The final conclusion is that this exercise helped me to put additional attention to Ahold Delhaize. I truly think that they can keep up the pace of growing their dividends with at least 8% annually over the next 5 years. Therefore the recent price drop to the low 22’s provided me an excellent buying opportunity.


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Disclaimer

I’m not a certified financial planner/advisor nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I’m not a finance professional through formal education. I’m a person who believes and takes pride in a sense of freedom, satisfaction, fulfillment and empowerment that I get from being financially competent and being conscious managing my personal money. The contents on this blog are for informational and entertainment purposes only and does not constitute financial, accounting, or legal advice. I can’t promise that the information shared on my blog is appropriate for you or anyone else. By reading this blog, you agree to hold me harmless from any ramifications, financial or otherwise, that occur to you as a result of acting on information provided on this blog.

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It's my desire to retire early via Dividend Growth Investing as a passive income stream. This is not easy and especially when living in Europe. That's why I started this blog and share my journey: to give you a European perspective.

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Jon Azkue
Jon Azkue
2 months ago

I always wondered about the Chowder Rule. Thanks for bringing the subject into the table. I think it is a great tool to evaluate our dividend investments when used with other techniques. I also think that a dividend yield between 4-6% with a CAGR between 8-10% is a great area for a nice and consistent growth without putting at risk the dividend being cut in the future (like Enagas or Red Electrica). what do you think?

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