The Chowder Rule Explained

Updated March 22nd, 2016

The Chowder Rule has nothing to do with soup… The name is a bit misleading.

The Chowder Rule is not a commonly used financial metric. With that said, The Chowder Rule is
an excellent tool to have in your dividend growth investing tool kit.

A brief definition of The Chowder Rule is below:

The Chowder Rule is a rule-based system used to identify dividend growth stocks with strong
total return potential by combining dividend yield and dividend growth.

The Chowder Rule was invented and popularized by Seeking Alpha contributor Chowder. The
rule gets its name from the Seeking Alpha contributor.

The Chowder Rule is applied differently to different stocks. The criteria and rule are below:

Rule 1: If stock has a dividend yield greater than 3%, its 5-year dividend growth rate plus its
dividend yield must be greater than 12%.

Rule 2: 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%.

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

This article examines the methodology of the Chowder Rule. The article also lists all stocks with
25+ years of steady or rising dividends that pass the Chowder Rule.

The Chowder Rule

Intelligent Rules

The Chowder Rule combines 2 intelligent financial ideas:

Total Return Investing

Having a Margin of Safety

Total return investing is a strategy where investors look for businesses with the highest expected
compound annual growth rate. The expected compound annual growth rate is dividend yield +
expected earnings-per-share growth.

Total return investing combines growth and dividends. It is a close proxy for dividend growth
investing.

The ‘Margin of Safety’ concept was popularized by Warren Buffett’s mentor (and value investing
pioneer) Benjamin Graham.

Benjamin Graham required a margin of safety in his investments. If he thought the fair value of a
stock was $100, he wasn’t willing to pay $100 for it. Graham typically required a 33% margin of
safety. In the $100 example, Graham would only pay ~$67 for the stock.

Combining the margin of safety principle with business trading below liquidation value allowed
Graham to compound his wealth at around 20% a year for decades.

The Goal of The Chowder Rule

The goal of the Chowder Rule is to create a long-term compound annual growth rate of over 8%.

The Chowder Rule applies both ‘Margin of Safety’ and ‘Total Return’ thinking to accomplish this
goal.

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 utility 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. The valuation of a stock should be considered as well after it passes the
Chowder Rule.

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. The dividend growth rate shows tremendous growth – but this is not sustainable. This
is because the payout ratio has increased from 10% to 60% in 5 years. That is where the illusory
growth comes from.

Earnings-per-share growth is usually a better indicator of underlying business growth than

dividend growth.

Earnings-per-share numbers are far from foolproof. 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 a reasonable estimate of future growth that is based on:

Historical earnings-per-share growth

Historical dividend growth

Future growth expectations

Estimating future growth does put human bias into the investment decision. It also eliminates
errors from accounting irregularities or one time earnings (or dividend) spikes or declines. The
goal in estimating future growth is to be reasonable and cautious, not to be rigid.

Sure Dividend Stocks & The Chowder Rule

There are currently 182 stocks in the Sure Dividend database. Each stock has 25 or more years
of dividend payments without a reduction.

Only 22 Sure Dividend Stocks pass the Chowder Rule test at this time.

Interestingly, only 2 Dividend Aristocrats pass the test at this time. Archer-Daniels-Midland
(ADM) and Emerson Electric (EMR) are the two Dividend Aristocrats that pass the Chowder Rule.

All 22 Sure Dividend stocks that pass the Chowder Rule are shown below:

Helmerich & Payne (HP)

Dividend Yield: 4.5%

Growth Rate: 10.3%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 14.8%

Cummins (CMI)

Dividend Yield: 3.5%

Growth Rate: 14.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 17.5%

Waddell & Reed (WDR)

Dividend Yield: 7.6%

Growth Rate: 10.2%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 17.8%

Weir Group Plc

Dividend Yield: 4.2%

Growth Rate: 12.5%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 16.7%

Phillips 66 Partners (PSXP)

Dividend Yield: 3.0%

Growth Rate: 15.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 18.0%

Johnson Controls (JCI)

Dividend Yield: 3.0%

Growth Rate: 10.3%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 13.3%

Archer-Daniels-Midland (ADM)

Dividend Yield: 3.1%

Growth Rate: 10.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 13.1%

Caterpillar (CAT)

Dividend Yield: 4.1%

Growth Rate: 9.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 13.1%

Emerson Electric (EMR)

Dividend Yield: 3.5%

Growth Rate: 9.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 12.5%

Flowers Foods (FLO)

Dividend Yield: 3.1%

Growth Rate: 13.3%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 16.4%

Enbridge (ENB)

Dividend Yield: 4.2%

Growth Rate: 10.0%

Chowder Rule Minimum: 12% because dividend yield is greater than 3%

Chowder Rule Score: 14.2%

Nike (NKE)

Dividend Yield: 1.0%

Growth Rate: 17.0%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 18.0%

Novo Nordisk (NVO)

Dividend Yield: 1.8%

Growth Rate: 18.3%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 20.1%

Spectris Plc

Dividend Yield: 2.7%

Growth Rate: 13.0%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 15.7%

Rotork Plc

Dividend Yield: 2.7%

Growth Rate: 13.7%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 16.4%

Deere & Company (DE)

Dividend Yield: 2.9%

Growth Rate: 13.3%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 16.2%

Tennant Company (TNC)

Dividend Yield: 1.6%

Growth Rate: 13.5%

Chowder Rule Minimum: 15% because dividend yield is less than 3%

Chowder Rule Score: 15.1%

Fortis

Dividend Yield: 3.8%

Growth Rate: 8.8%

Chowder Rule Minimum: 8% because it is a utility

Chowder Rule Score: 12.6%

Canadian Utilities

Dividend Yield: 3.7%

Growth Rate: 7.3%

Chowder Rule Minimum: 8% because it is a utility

Chowder Rule Score: 11.0%

California Water Service (CWT)

Dividend Yield: 2.7%

Growth Rate: 10.8%

Chowder Rule Minimum: 8% because it is a utility

Chowder Rule Score: 13.5%

American States Water (AWR)

Dividend Yield: 2.3%

Growth Rate: 8.5%

Chowder Rule Minimum: 8% because it is a utility

Chowder Rule Score: 10.8%

Questar Corporation (STR)

Dividend Yield: 3.6%

Growth Rate: 5.0%

Chowder Rule Minimum: 8% because it is a utility

Chowder Rule Score: 8.6%

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.

THE CHOWDER RULE (as in SeekingAlpha)

I notice that a lot of people are now referring to The Chowder Rule. I thought that as long as
people are going to use it as a criteria in their stock selection, I would explain how and where it
came from.

In order to understand the importance of The Chowder Rule, and how it relates to the stock
selection process, one needs to understand the concept of dividend growth investing as I see it.
One needs to understand what I was trying to accomplish and why. Once you understand this,
you may be able to adjust the numbers to suite your needs, or accept it and apply it as it is.
When I discovered dividend growth investing I was surprised that there wasn't a blue print to
describe exactly what it was. I saw where people had various views or ideas of what dividend
growth investing meant to them.

One concept I came across stated that any company whose expected long-term dividend growth
rate exceeded its current yield, was a dividend growth stock. I can see that as workable, but it
appears to have limitations. One would have to abandon owning high quality companies with
high yields, yet low dividend growth rates. One might get caught up with owning mostly low
yielding companies with high dividend growth rates that are unsustainable.

Keep in mind that there is usually a trade off between yield and dividend growth. My objective
was to find a balance between the two.

I do prefer a long history of dividend growth over a short one. I do prefer more dividend growth
over less. With the threat of higher interest rates affecting high yield companies, it is also
plausible that high dividend growth will slow, and low dividend growth will freeze or decline. So
again, I'm looking for balance between the two.

One of the problems with high dividend growth is that it eventually has to slow. So in my
opinion, I am better off trying to balance a high yield vs high dividend growth.

Another consideration about double digit dividend growth is the base from which it began. If a
company started with a dividend of 2 cents, it wouldn't be difficult to grow at double digits and it
wouldn't have much of an impact on the income stream either. Also, keep an eye on the payout
ratio. Just make sure it isn't astronomically high in order to provide dividend growth. A company
can't continue raising the payout ratio, so something has to give.

One thought that had an impact in applying The Chowder Rule was a stock that yields 1% has to
raise its dividend 20% to generate the same dollar increase in annual income that another stock
yielding 4% can achieve with a mere 5% hike.
Which growth rate is more realistically expected to be maintained over long time frames?

Most of the principles and concepts I apply have been taken from the book, "The Single Best
Investment" by Lowell Miller.

According to Miller, the hidden key to the single best investment is dividend growth. The reason
dividend growth is so important for long-term investors is because dividend growth is what
drives the compounding machine in a way that is certain and inevitable. Dividend growth is an
authoritative force that compels higher returns regardless of other factors affecting the stock
market.

An important point is that an instrument that produces income is valued based on the amount
of income it produces. The more income it produces, the more valuable the asset.

Keep in mind, you not only receive greater income as the years go by, you also get a rising stock
price because the asset producing the income is worth more as the income it produces
increases.

Stop and think about it for a minute. When you look at the long dividend growth history of
companies like KO, PG and JNJ, if share price didn't keep up with dividend growth, they would
have yields of 10%, 15% or more -- and the market isn't going to allow that to happen.

(The following paragraph is the essence of The Chowder Rule!)

So in effect, you get a "double dip" when you invest in high yield stocks that have high rising
dividends. You get the income that increases to meet or surpass inflation, and you get the effect
of that rising income on the stock price, which is to force price higher.

Dividend growth investing to me means that I am creating a compounding machine, not playing
the market. Dividend growth is the energy that drives that machine.
In the book, "What Works on Wall Street" by James O'Shaughnessey, he states ... "It's impossible
to monkey with a dividend yield." The author found that high yield was a much more effective
factor in stock price performance when what he calls "large" stocks are studied. Among large
stocks, he found that the highest-yielding stocks out-performed the overall universe 91% of the
time over all rolling ten year periods.

Miller/Howard Investments revisited the issue of high yield and dividend growth with the help of
Ford Investor Services, an institutional database and research organization based in San Diego.
Using their data base going back to 1970, they found that high-yield stocks outperform the
market over long periods on both an absolute and a risk-adjusted basis. The key is to own
quality! ... (I hope you got that.)

Once you understand the concept, the next step is to come up with a plan of action.

This leads to a formula I adopted. I call it "The Success Formula That Never Fails."

High Quality + High Current Yield + High Growth of Yield = High Total Return.

High Quality is defined as having superior financial strength. A company must have a 1 or 2
rating for Safety with Value Line, or a BBB+ rating or better with S&P. Both of these Financial
Strength ratings indicate investment grade quality. ... Anything that doesn't meet the High
Quality definition is considered speculation and managed differently within the portfolio.

High Current Yield is defined as a yield that is at least 50% above the yield offered by the S&P
500. Therefore, if the S&P 500 has a 2% yield, then 3% is the minimum number for purchase
under the formula stated above.

High Growth of Yield is defined as companies that raise their dividend at a rate of 5% or more.

With the "Success Formula" in hand, I needed to come up with a way for it to support my long-
term objectives.
My long-term objective is to grow the portfolio at an 8% compounded annual growth rate
(OTCPK:CAGR). I decided I would try to take advantage of total dividend return, current yield plus
a 5 year CAGR to help support my long-term 8% CAGR objective. This total dividend return
concept was dubbed The Chowder Rule by a Contributor on Seeking Alpha by the name of J.D.
Welch.

Since High Current Yield called for a 3% minimum yield, based on the 50% above the S&P 500
yield concept, Howard Miller's 5% annual dividend growth minimum, when added to the yield
came out to 8%. That was exactly what my long-term goals were and I established those goals
before I read Miller's book.

I then decided I would place a "moat" around that 8% number as a margin of safety because I
knew as price rises, yields come down and the original Chowder Rule number will as well.

I thought I would go 50% higher and came up with a Chowder Rule number of 12% as a total
return objective. ... If others want to adjust the number to meet their objectives, that's fine. As
long as it supports what it is you are trying to do, you'll get no argument from me. ... Ha!

Anyway, that 12% total dividend return number is now referred to as The Chowder Rule by
many. So basically, if a stock has a 3% yield, I need a 5 year dividend growth rate of 9% to get my
12% number. If a stock has a 4% yield, I only need an 8% dividend growth rate.

For example:

CVX has a yield of 3.1% and a 5 year CAGR of 9.13%. When added together, I get a Chowder Rule
number of 12.23%. ... It qualifies for purchase as long as the fundamentals and valuations meet
your standards.

As I delved deeper into the concept of dividend growth investing, I realized I needed to focus on
the safety of the dividend first. As I researched, I found that a lot of companies with solid
dividends weren't able to grow their business like a lot of other companies, so their dividend
growth may not be as robust. Utility companies are a good example of this.

Since my long-term goal is to achieve an 8% CAGR, I thought I would use that number for utility
companies since it still supported my objective. I include telecom and MLP's under the utility
umbrella. So for example, D has a yield of 3.4% and a 5 year CAGR of 6.99%, giving me a
Chowder Rule number of 10.39%. It qualifies for purchase as long as the fundamentals and
valuations meet your standards.

I know there are those who wish to own companies with yields below 3%, yet have higher
dividend growth. I'm not opposed to this, but keep in mind, the lower the yield, the more you
must rely on capital appreciation to achieve High Total Return.

I decided that if I'm willing to accept a yield below 3%, I must require a higher dividend growth
rate. I needed a higher Chowder Rule number to serve as a margin of safety. I decided to use
15% for companies yielding less than 3%.

So for example:

DE has a yield of 2.4% and a 5 year CAGR of 13.84% for a Chowder Rule number of 16.24%. It
qualifies for purchase as long as the fundamentals and valuations meet your standards.

Again, these numbers were designed around my long-term objectives. If your goals are different,
you can adjust the numbers any way you wish as long as they support your goal. Just keep in
mind that the lower the yield, the more you must rely on price appreciation.

I applied The Chowder Rule as a way to take the pressure off of price appreciation. I was looking
for the "double dip" balance.