Next week, a few adjustments will flow through to our Dividend Safety Scores to further improve their ability to identify companies that are most at risk of cutting their dividends in the future.
We expect these adjustments to make the scores even more thorough, timely, and accurate going forward.
However, these improvements will cause some companies to experience a score change.
Although the vast majority of companies will not see a material change in their risk classification, we want to keep you as informed as possible.
Members will receive an email early next week that lists any of their holdings that have experienced a meaningful score change, along with analysis explaining the reasoning behind the company’s new score.
In this article, we will do our best to outline the improvements we are making, address how different types of companies will be affected, and answer questions you likely have.
Our hope is help everyone understand the improvements being made, learn why the improvements are helpful, and remain very comfortable using our Dividend Safety Scores.
If it ain’t broke, why fix it?
The first question you might have is why we would tinker with our Dividend Safety Scores if they were already working fairly well.
After all, you can see that almost all dividend cuts that have been announced since we’ve been in business have come from companies with Dividend Safety Scores near 40 or below. You can see more details about our real-time track record here.
We want to make it clear that the underlying principles and scoring methodology we use will not change. We are not overhauling how Dividend Safety Scores work by any means.
All we are doing is incorporating some new insights and financial metrics that are now available in our database to help us further pinpoint dividend risk. We will review these new metrics shortly.
For now, the takeaway is that our scores will remain focused on the factors that have helped them be successful, and the new scores will be interpreted the same way as they always have:
As we mentioned earlier, we expect these changes to make our scores even more thorough and accurate while also reducing their volatility unless something has really changed with a business.
What’s the new data being incorporated?
Here are the new metrics our updated scores will make use of:
1) Forward payout ratios
A payout ratio expresses the percentage of a company’s earnings that have been paid out as a dividend.
Our Dividend Safety Scores currently calculate payout ratios by using company’s total earnings reported over the trailing 12-month period.
While this methodology works well to capture a snapshot of recent business conditions, it is not always a good indicator of where the company’s earnings are going in the future.
We now have access to analysts’ forward earnings estimates for thousands of companies. As a result, we can calculate a company’s projected payout ratio for the year ahead, identifying situations where a company’s dividend risk is expected to significantly increase or decrease and adjusting its Dividend Safety Score accordingly.
Our calculations will continue using trailing 12-month payout ratios as well since they reflect actual business results, but implementing a blended assessment of trailing and forward payout ratios will help us spot companies with changing risk profiles even sooner in many cases.
2) Cash flow metrics for REITs and MLPs
Real estate investment trusts (REITs) and master limited partnerships (MLPs) report unique financial metrics that are much more informative about their health rather than looking at earnings.
Specifically, REITs report funds from operations (FFO) and adjusted funds from operations (AFFO). You can learn more about these metrics here. FFO and AFFO are much better way to evaluate a REIT’s operating cash flow and free cash flow, respectively.
Our current scoring system does its best to estimate a REIT’s FFO by adding depreciation and amortization to net income, but this can be prone to errors (e.g. a REIT sells some properties, realizing a large gain). We also did not have a way to approximate AFFO.
Fortunately, our new data will have actual FFO and AFFO values at our disposal. We will use these metrics to calculate trailing and forward payout ratios and quarterly cash flow growth for REITs, providing much greater visibility into their dividend safety.
The story is similar for MLPs, which report distributable cash flow (DCF). DCF can be thought of as a free cash flow measure for MLPs (learn more here), with the main difference being that it excludes their spending on growth projects, which can be substantial.
We had been trying to estimate DCF by adding depreciation and amortization to net income. While this was better than nothing, it was far from ideal.
Now we have have actual DCF data for MLPs, which we will use for trailing and forward payout ratios, as well as quarterly DCF growth.
Simply put, gaining access to industry-specific cash flow metrics for REITs and MLPs is a big win for our scores and will help income investors navigate these high-yield areas of the market even more responsibly to reduce surprises.
3) Off-balance-sheet debt
Investors trying to size up a company’s financial leverage will typically look at ratios such as debt / EBITDA, debt-to-equity, or debt-to-capital.
Almost all of the time, the “debt” part of these ratios is taken straight from the firm’s balance sheet and reflects loans the company has taken out.
However, some companies have significantly more financial obligations than those printed clearly on the balance sheet. Unfunded pension debt and operating leases are two primary examples.
Unfunded pension debt is fairly straightforward – a company has a defined benefit pension plan and has promised to pay employees a certain amount of benefits each year after they retire. The company makes contributions to its pension plan which are invested to fund these benefit obligations.
Many times, a pension plan’s contributed assets are less than the expected value of benefits to be paid out in the future. Sometimes the difference is staggering, but unfunded pension debt is buried in footnotes of companies’ reports rather than on the balance sheet.
We are now able to capture any unfunded pension debt a company has and add it to their total debt when calculating various leverage metrics.
Operating leases are a bit trickier to understand. Some companies own the buildings, equipment, and property needed to run their businesses. Other companies will instead lease these assets, choosing to make periodic payments over a number of years instead.
Some of these arrangements are classified as operating leases. Leasing assets is a type of financing agreement, which puts the company on the hook for putting up the remaining lease payments in return for use of an asset.
However, operating lease liabilities do not show up on the balance sheet as debt. The company records rent expense relating to the operating leases, but that’s the extent of it.
Credit rating agencies will typically estimate a company’s total operating lease debt by applying a multiple to the firm’s annual rent expense. Our scores will now incorporate any off-balance-sheet operating lease debt by applying the same treatment and adding that figure to the company’s overall debt.
4) Non-GAAP earnings
Companies are required to report earnings based on Generally Accepted Accounting Principles (GAAP) when they file financial statements. However, many businesses will also report “non-GAAP” earnings, which adjust out one-time events, such as restructuring charges and non-cash impairments, to paint a truer picture of their operating performance.
It’s true that some “non-GAAP” earnings figures are controversial because they make a firm’s results look better than they perhaps should. However, non-GAAP earnings usually do a fair job of excluding noisy factors to better reflect a company’s underlying operations.
Our scores previously only had GAAP earnings at our disposal, which would periodically cause volatility if a company’s earnings shot up or down for accounting reasons that didn’t reflect actual corporate performance.
With non-GAAP earnings figures now at our fingertips, our scores will be able to exclude this noise to calculate more stable and realistic payout ratios, earnings growth, and more.
5) Uninterrupted dividend streaks
Many income investors like to know how many consecutive years a company has raised its dividend to gain confidence in its ability to continue safe dividends.
We used the length of a company’s dividend growth streak as a factor in our Dividend Safety Scores. However, there are many examples of companies that might not have a long dividend growth streak but have paid uninterrupted dividends without reduction for many decades.
We have cleaner dividend history data available now that better adjusts for trickier issues like stock splits and special dividends to identify these companies, which are now being rewarded more in our scoring system.
A long history of paying uninterrupted dividends is often a sign that the company’s business is managed conservatively and committed to its payout.
What types of companies are most affected by these improvements?
Generally speaking, REITs, MLPs, and consumer retailers experienced the most change, largely due to the inclusion of FFO / AFFO / DCF / off-balance-sheet debt (many retailers lease their properties) metrics.
Otherwise, score changes really depend on a company’s unique situation – Did they have a lot of off-balance-sheet debt that wasn’t being recognized before? Was their GAAP earnings noisy and over or understating payout ratios and growth? Was there a long uninterrupted dividend streak we were missing? Are forward earnings expected to significantly increase or decrease?
It’s worth repeating that the vast majority of companies will not see a material change in their risk classification. We just really don’t want you to be surprised when you see some scores shift around.
When is the Dividend Safety Score update taking place?
The update will take place early next week. We will send out an email when the score changes go live.
How will I know which scores changed significantly in my portfolio?
In the email we send out early next week, you will receive a list of any stocks in your portfolio that have seen their scores drop to a level that merits a review. Each flagged stock will be linked to a page of analysis you can read that explains the fundamental factors supporting its new score.
If you have any other questions, please leave a comment below or email us at email@example.com.
We know our Dividend Safety Scores are a very important part of the portfolio management process. While we are excited to make our scores smarter with these improvements, we also know change can be uncomfortable. We will be here for you every step of the way.
Wonderful service, an integral part of my DD. The upgrades are just that, it is great to see this service evolve. Best of luck and thanks, Marc
Thank you, Marc. We are excited to continue improving the service. I hope you enjoy the holidays.
Nice to see you improving an already great product! Thank you. Also, can you tell me when dividend safety scores are updated on a stock. Is it daily or after an earnings release?
Thank you for your support. We couldn’t make these improvements without it.
Dividend Safety Scores update weekly, but any significant adjustments that occur happen when stocks release earnings. The improvements we are making early next week won’t change that, but they should reduce score volatility unless something major has changed with a company’s metrics.
Very pleased to see that your on point by ‘continually improving’ a critical aspect of your service. Your service is integral to my DD.
Many thanks and keep up the good work!👍
Thanks a lot, Bruce! I’m really glad you are continuing to find the service helpful, and we’re excited to keep making it better.
Thank you for your explanation of the warranted upgrades of your Dividend Safety Score. Also, a tardy ‘thank you’ for the ability to maintain 7 instead of just 5 portfolios (which was available when I initially subscribed.) I assume the email next week will include just the stocks in our default (first) portfolio? Good to see DSS continue improving the information upon which we base, at least in part, our investment decisions.
You are very welcome. The email next week will cover stocks in all of your portfolios, not just the first one.
Thanks for your support!
Wonderful! So glad to get even bettee numbers on REITs. You guys rock!
Great Brian! Especially REITS & MPLs..
Thank you, Gerry. I’m really looking forward to shining more light on the REIT and MLP industries. Those companies can be trickier to analyze due to their unique business models, but improving our data quality will make the task a little easier.
I appreciate your intent for continuous improvement. Yet, I’m concerned about your use of analysts’ forward projections, as well as non-GAAP earnings info. This can become a slippery-slope toward using less credible information.
Research information I have observed indicates analysts’ are not very good at predicting the future. Also, many publications have adversary commented on the increasing use of non-GAAP info.
I assume (hope?) you will be carefully screening this type of information to look for any “games” being played by those companies.
You indicate the Pay-out ratio scoring will become blended. Are you willing to share what weighting the FUTURE Pay-Out ratios will have on the overall payout ratio score?
I really appreciate your feedback, thank you. It was with great caution that I approached both forward projections and non-GAAP earnings information.
During my time as an equity analyst at a large investment firm, I generally agree that most sell side analysts are not good at forecasting.
In the vast majority of cases we’ve seen while testing out this new data, analysts projections simply extrapolate a company’s recent performance into the next year, resulting in a very similar payout ratio compared to the trailing 12-month figure.
In other words, in most of these cases, there wouldn’t be much of a difference using a blended or trailing 12-month approach exclusively, if that makes sense.
What’s more interesting to us and can help with our scores is when something changes that hasn’t fully or even partially reflected itself in a company’s trailing 12-month results. A significant patent loss is one example, and we would gain visibility into any expected erosion in future earnings that investors might want to know about.
There are a number of other factors at work to compute our scores, but I would estimate that forward payout ratios account for no more than 10-15% of most scores.
The decision to use non-GAAP financials as a component of our scores was not made lightly, and I understand your concerns about some companies playing accounting games.
One of the challenges we faced with our original scores was unnecessary score volatility caused by noisy GAAP figures – pension accounting, non-cash impairments, truly one-time restructuring charges, acquisitions, etc.
With several years of experience observing the financial data flowing into our database and seeing how it affects different companies’ scores, it became clear that using adjusted earnings figures, when available, would be a net positive.
With that said, many other components of our scores do not use adjusted earnings figures. I believe it would be very difficult for a company playing earnings games to score high for Dividend Safety as there tend to be other risk factors we would likely identify.
Fortunately, the SEC is also cracking down harder on companies reporting non-GAAP figures in an effort to make sure they are more meaningful rather than potentially misleading: https://www.cricpa.com/gaap-versus-non-gaap/
The technology sector is arguably the biggest abuser of non-GAAP accounting with how they treat stock options and subscription revenue. While there are some major dividend stocks in tech, most are in other sectors.
Furthermore, I’ve noticed many companies that are known for reporting non-GAAP figures become more transparent and upfront with their reporting this year, and I suspect this trend will only continue. Hopefully this increasing pressure by the SEC further reduces risk of companies investors being misled.
Let me know if you have any questions, and thank you again for chiming in.
Thank you for the additional background comments. Also, thanks for your transparency in the scoring process.
I feel better with these updates and will continue relying on Simply Safe Dividends as an important part of my investing evaluations.
You are welcome, Steve. As always, feel free to reach out if any questions ever pop up.
Ive got a question that you may have answered elsewhere but ive not seen anything regarding the scores of REITs. With REITS, are you using FFO, AFFO or EPS in their calculations? It would be great if you could replace EPS with FFO and/or AFFO on their information pages. Is this something thats coming, or in the works, or is it not something youre planning on doing?
Ummmmm, ok im embarrassed. Note to self, read the article before asking stupid questions. Thanks this is great news!
The other additions are great too. Part of my original question is still valid though. Will FFO replace EPS on a REITs information page? Thatd be nice so we have easy access to those numbers.
That said, thanks a lot for this great service and hope you and yours have a great holiday.
No problem! Right now, we are straddling several different sources of data. The information we added to our database this fall was a huge leap.
We will finish the major integration work that was needed to incorporate this information into our scores next week. We will then need to explore sourcing the new data into other parts of the website, which will remain powered by our original data for now.
I agree it would be great to replace EPS with FFO and AFFO data on a REIT’s information page. We will be looking into it as we continue making progress.
Have a great holiday season as well, and thanks for the feedback!
Thank you for the explanation of the updates to Simply Safe Dividends. I appreciate your efforts to improve your already great service. Keep up the fantastic work!
Thank you for your kind words! I know improvements can sometimes feel uncomfortable, but we will do our very best to minimize any discomfort and keep you fully in the loop.
Really looking forward to seeing the results of these changes should nice I own quite a few REITs. Thanks for all the hard work!! Rick N
Thanks for commenting, Rick. You are not alone with your REIT ownership, and I’m looking forward to the new data helping you better evaluate them.
As usual, your total transparency is very refreshing and appreciated.
Your site is my first stop with DGI due diligence.
Thank you for your kind note. We will always be here for you and will lay everything out on the table as best as we can.
I’m humbled to hear that we are your first stop for DGI research, and I look forward to doing everything we can to keep it that way!
Great additional info. Thanks Brian!
You are welcome, rkc! Thanks for being on board with these adjustments.
Bravo. Looking forward to analyzing the new numbers on all my stocks.
Thanks, Cynthia. I’ll be here if you have any questions along the way!
The upgrade improves an already invaluable service your website provides. Flagging significant changes in safety scores for any given stock on an ongoing basis would be of great value in managing a portfolio.
Thank you for your feedback. Flagging changes and/or issuing some sort of alert when scores meaningfully change is a really interesting idea that is on our radar.
As we continue to get past some of the heavy lifting that is needed with our expanded database, I’m excited to explore the new ideas we have.
Great updates to SSD Brian. I’m a new subscriber using SSD as one of my tools to research investment opportunities…you must have been reading my mind!
Thank you for your business!
I’m really glad our upcoming improvements are aligned with your thoughts, and I’m excited to hopefully continue making SSD an even more valuable tool for your research process.
I’m always here if you ever need anything.
Since I have a fair share of reits I’m kind of nervous for the new report….kind of the way you feel when you have to go to the doctor and get your annual blood work! I actually didn’t know that the safety scores changed on a (weekly?) basis…But after buying one dog (which had a decent score when I bought it) I got a lesson in that. Anyway – thanks for your continued hard work. Kay
Thanks for sharing your thoughts, and I completely understand how you feel. I’ll be here all next week after the changes go live to answer any questions you have. At the very least, you will finally get to see a snapshot of the latest REIT-specific metrics for holdings that experience a noticeable score change. I look forward to touching base next week, and I hope you enjoy the rest of your weekend!
Thanks for the improvement in scoring.
I recommend identifying the weight of the forecasts in your scoring. Everyone wants to be a believer or they would not be investing. Believing is one thing – how much to believe those unknown to us is another.
Thanks for your support and feedback.
One of our other goals with the score improvements we made was to remove some of the “black box” feel they had. The expanded analysis section helps explain some of the most important factors behind a company’s score and hopefully helps investors think more critically about a firm’s dividend quality to make an even more informed decision.
Breaking out exact weights and metric thresholds is a little challenging because they vary between sectors and can depend on a company’s unique financial situation. I’m all for continuing to make our scores easier to understand and did my best to approximate the importance of different buckets feeding into our scores:
– Payout ratios: 25-45%
– Debt and liquidity metrics: 20-40%
– Long-term dividend track record: 10-20%
– Business quality metrics (ROIC, FCF generation, etc.): 10-20%
– Recent business results (e.g. earnings growth): 5-20%
Your service has been an integral part of my investing for almost two years. I find it very helpful and it has definitely helped my returns. I’m probably a broken record on this point, but I would still love to see a link that shows historical changes in dividend safety and growth along with projected trend. Every time I receive a dividend, I look at your scores and find some are occasionally fluctuating by as much as 20-25 points.
Thanks for your nice note, and I’m really happy our service has been helpful for your returns.
You’re not a broken record at all, and we take everyone’s feedback very seriously. Historical score changes are a hot topic we have heard about from other members as well.
We believe the updates we made will significantly reduce score fluctuations unless something meaningful has occurred. I know that doesn’t get at the historical changes that have taken place, but it should make for a more stable system going forward.
On the historical score change front, we have some work to do to really dive into the changes that occur going forward and determine if they’re more signal than noise. If the changes do say something about the future (our current scores are already forward-looking), than it would be great to incorporate them.
We just want to be really careful with the information we put in front of investors to avoid creating misleading insights or giving them a false sense of confidence.
I think the underlying issue is that investors want stocks that are less likely to see their scores deteriorate after they buy. Knowing if a company’s dividend is becoming increasingly safe or risky and why that’s happening is important information. Historical score trends could have some predictive value, or they may not.
Either way, this issue is on our radar, and we look forward to thoughtfully exploring it and reporting our findings in the future.
I’d like to second Bigdog’s comment … I’ve submitted several times that being able to graph a historical dividend safety (and growth) score would be very helpful and (for me) time saving.
Thanks for all your efforts to make SSD as useful as possible.
Thank you very much for your feedback. I know a lot of our members are interested in historical score information as well, and we are excited to invest time exploring the topic.
Let me know if you have any questions after reading the reply I posted to Bigdog’s comment.
Thanks for your continued support of SSD, and I hope you enjoy the holidays.
I appreciate the time and effort you put into keeping us informed.
Merry Xmas and Happy New Year! Wishing everyone excellent returns, dividend growth and health!
Thank you, Guerrero! Wishing you a Merry Christmas and Happy New Year as well.
I welcome, understand, applaud, and look forward to incorporating your revised DS scores into my portfolio strategy. Your release today was most useful to highlight adjustments into my work product.
Do you plan the same soon for DG?
Is a solution for portfolio cash inclusion still forthcoming?
Overall, very well done so far. Thank you.
Thanks for your excitement with our updated scores, and I’m glad our email was helpful.
We haven’t changed anything with our Dividend Growth Scores at this point. With a lot of heavy-lifting now complete on the Safety Score side, we will be able to start evaluating other improvement projects to take on.
Accommodating portfolios’ cash balances is still on our radar as well. Thanks for the feedback, and we look forward to sharing more progress in the future.
Hey Brian, just checked the updates and looks solid. I do have one glaring negative though. I realize youre using software to put together the data for each security, but there should be a way to differentiate between an actual dividend cut or a spin off or stock split. This is just one example, but Ventas (VTR) has actually paid increasing dividends for 10 years (20+ if you count the fact that they kept the dividend steady during financial crisis). Spinning off their skilled nursing segment makes it appear that they cut the div, and the write up even mentions it, so im sure that affects the safety score a bit.
As far as solutions, I understand you cant possibly research every single company out there, but maybe give us the ability to flag a company’s report which would give you a heads up and you could manually fix specific company reports? Its pretty important though, as it could potentially steer people away or to certain investments. Maybe theres a way to implement these “flags” into your research software? Maybe others have ideas. Thanks for listening!
We noticed some noisy breaks in uninterrupted dividend streaks as well, mostly due to spinoffs like you mentioned. We did adjust the dividend streak numbers that were contributing to those companies’ scores for the cases we identified, but some others have probably slipped through the cracks. The text still reads incorrectly for all of them, too.
We plan to explore this issue more thoroughly over the coming months. The good news is that we have a solid system in place to make incremental improvements to our scoring system. We are all ears if you come across any other unusual cases for us to investigate!
Updating the process with which the final numbers are generated is reassuring and appreciated. Like others, SSD is one of my resources used in doing my due diligence. I joined 2 yrs ago and SSD is a must have for me in analyzing potential adds to portfolio.
Thank you for embracing the updates we made, and I hope the expanded analysis helps with your due diligence process.
I really appreciate your business and am always here if you have any questions or feedback on how we can continue improving the service.
The continual updating of the information you provide is another reason I subscribe to your excellent service. I joined earlier this year and as long as I continue to invest in individual dividend paying stocks, I will remain a loyal SSD subscriber.
The narrative in the REIT reports is spot on providing REIT specific information. But the graphs still refer to EPS and FCF. Also the Net Debt/EBITDA isn’t clear in the narrative. Can you provide an explanation as to how to interpret these earnings and free cash flow references? That would also pertain to the payout ratios in the graphs as well.
I’m really glad you are enjoying the updated information! We couldn’t make these improvements without your support, so thank you again for your business.
You are correct that there is currently a disconnect between the information cited in the text analysis and the tables and charts for REITs (and MLPs). For now, it would be best to ignore the EPS and FCF information presented for those companies in the tables and charts and instead focus on the most recent figures cited in the text.
We are straddling several sources of data right now and plan to explore bringing all of the new information we have access to into the tables and charts so that everything is consistent. We will be sure to keep everyone updated as we learn more and make progress.