Rule #1: The Quality Rule
The quality rule is based on the common-sense notion that high-quality businesses have greater wealth compounding abilities than low-quality businesses. The problem is how to define a “high-quality business.”
High-quality businesses is a long corporate history.
Rule #2: The Bargain Rule
When stock prices are cheap, dividend yields are higher.Accordingly, the bargain rule ranks stocks by their dividend yields (the higher the better). This provides the two-pronged advantage of generating more portfolio income and also helping to identify stocks with low valuation metrics (such as the price-to-earnings ratio, the price-to-book ratio, or the price-to-free-cash-flow ratio).
Rule #3: The Growth Rule
Indeed, business growth will eventually translate to a higher share price if investors can ignore the short-term vicissitudes of the stock market.
With this in mind, the Growth Rule recommends ranking stocks by their earnings-per-share growth estimates. This benefits investors through both share price appreciation and higher dividend payments, as there will be more corporate profits to be distributed to shareholders.
If a company cuts its dividend, there are two potential causes:
- Management is financially unable to make the dividend payment
- Management is unwilling to continue paying dividends