The Ridiculously Simple Framework I Use to Generate Investment Ideas

I recently wrote about what a typical day looks like as an early retiree.

The whole point of early retirement was freedom. I wanted to be in control of my time. Now that I can do whatever I want whenever I want, I find I’m defaulting more to researching stocks.

I can’t help it; I really do enjoy cracking open a company’s latest annual report and settling in for a couple of hours. Like any habit, reading annual reports compounds over time. When I first started reading them, I’d struggle to get through even a few pages. Now I know what are the important parts and what I can safely skim (like the ESG part), and the whole process usually doesn’t take more than a few hours.

I’ll then check out secondary pieces of research, read the last few conference call transcripts, and, perhaps most importantly, put my thoughts onto paper. I find writing about my ideas to be incredibly beneficial. It really helps to clarify my thoughts and to crystalize why I might find a certain stock appealing.

This is all fine and good, but it doesn’t really help with something a lot of investors struggle with — finding ideas. They can’t even find stocks they’re interested in owning, never mind the rest of it.

Today’s post will help with the idea generation process. It’s the exact method I use to identify interesting stocks that are worthy of a potential place in my portfolio. It’s a ridiculously simple framework too, something you can easily steal and adapt for your own portfolio.

Let’s take a closer look.

My core investment principles

First, let me share my core investing principles, then let me explain how they truly are the key to everything.

I used to invest with the goal of generating the best total return. It’s why I initially embraced a deep value approach. But, over time, I realized that method didn’t really mesh up with my goals. Plus, to be completely honest, I stunk at it.

I switched to a goals-based approach, figuring out quickly that dividend investing meshed really well with my goals of early retirement.

Identifying the goal was step one. At that point, step two became pretty easy. I wanted a simple investing framework that would help me pick stocks that would help me achieve my goals. 

My goals were to retire early on an ever-increasing tsunami of dividend income, but I also wanted to grow my capital so I’d have the ability to make a difference later in life. Therefore, I’m mostly looking for dividend growth stocks with a decent yield today. I also want to identify stocks with sustainable payout ratios and that trade at fair value to minimize my downside.

I then converted those goals into the investment framework you see above. I target mature companies with healthy revenues and profits. I look in forgotten corners of the market to find gems other investors have missed. I insist on reasonable valuations and sustainable dividends. And I mostly focus on the Canadian market to limit the number of stocks in my universe.

I realize that I need to have at least a little bit of growth in my portfolio to get me to my goals. This is why dividend growth is an important metric. Ultimately, earnings growth is what drives dividend growth, so that’s really what I’m looking for. But dividend growth is a great proxy for earnings growth, especially in the initial screening part of the investment. I save the details for later on in the research process because I know that a company can pay a higher dividend without earnings following. Those are stocks I’ll tend to avoid, unless I can see a reasonable plan for increasing the bottom line.

Once you’ve identified what you’re looking for, looking for potential investments is pretty easy. You simply run any stock you come across through the checklist. These days, this takes me about 90 seconds. I ask myself, does this stock:

• Have mature business revenue and profit characteristics?

• Does it trade at a reasonable valuation?

• Does it pay a dividend?

• Does that dividend have potential to grow over time?

If a stock checks all those criteria, I add it to the list for further research.

Once you understand your own framework, you can do a number of things to identify interesting stocks to add to your watchlist. You can sort of stumble around Twitter or Seeking Alpha or the dividend investing community, like I do. That’ll help you uncover interesting ideas. You can do what Warren Buffett did in the 1950s and go through every stock in the market. Screeners make that a lot easier than it used to be. You can use your brokerage’s research or follow hedge fund managers or build up a network of like-minded investors. The sky really is the limit.

Just remember to filter each stock through your framework, and you’ll be fine. If adjustments are needed (like if too few or too many are making it past the initial filtering process), make them. Remember, you don’t have to invest in every stock you read about.

If you’re still struggling to come up with dividend investing ideas, sign up for the premium version of this newsletter, which is chock full of interesting dividend stock ideas. Some of the investments I’ve featured include:

• A unique royalty company already up 150%+ since it was first profiled… that only sells for 7× 2024’s expected earnings

• A recent dividend initiator with a terrific long-term record that’s up 25%+ since I wrote about it a few months ago

• A list of preferred shares that offered safe, 8%+ yields, plus capital gains potential (already up 10%+ in six months)

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Start your idea generation process with these interesting reads

I read a lot of stuff to help generate investment ideas. Here’s some of the good stuff I’ve checked out in the last few weeks.

Let’s start out with Alluvial Capital, who profiled an interesting Mexican consumer goods company — Herdez — which trades at approximately 6x EBITDA and 11x earnings. Not bad at all.

I like to follow the Canadian farmland market — it’s a fascinating market, plus I like to see how my friend Norm’s net worth is doing — so I await the annual FCC Farmland Values Report each year. 2023 was yet another great one for Canadian farmers, with values up some 11% over 2022.

One of the funniest stories I’ve read recently — OPM Wire on how he found his first job on Bay Street

Fascinating piece by Yet Another Value Blog, which questions whether there’s a quality bubble. He points out the valuation offered by so-called “quality” stocks like Costco or Chipotle is downright silly, and I’m inclined to agree with him. A brave piece to write considering how popular those stocks are.

I absolutely love how Dividend Growth Investor’s website hasn’t been updated since about 2010. He doesn’t care for all that; he’s laser-focused on good content, and he usually delivers. He recently wrote about The Return of the Dividend, sharing a prediction that many of the top tech companies will follow Facebook’s lead and start paying dividends. I fully agree, and think this is fertile ground for new research.

Your author profiled one of his favourite stocks over at Seeking Alpha, Exchange Income Corp. Exchange offers solid growth potential, trades at a great valuation, and has quietly been one of the best performing stocks on the entire TSX. Check this bad boy out.

Oh baby. That’ll do.

Have you ever thought about buying a vacation home? I sure have. Although I choose to rent my fun these days, I can certainly see the appeal of having a place in a sunny locale, plus you can rent it to make a little extra cash. Anyway, Dividend Daddy has a place in Puerto Vallarta, and he wrote a detailed guide about his experience buying the place. A great read.

This doesn’t really have much to do with dividend investing, but screw it. It’s in anyway. The absolutely zany story of a group of Colorado ranchers who altered rain gauges in an effort to get paid for worsening drought conditions from the feds. Then one of the co-conspirator escaped from prison…

Back to stocks. Here’s an excellent read on my friend Dabao’s One Foot Hurdle Substack, which looks to primarily focus on Asian stocks. This post is on Basso, a manufacturer of power tools that pays an almost 6% dividend yield and trades at a ridiculously low multiple.

An important message from My Own Advisor, who encourages investors to not worry so much about beating an index. Once I realized my goals had very little to do with beating an index, I simply stopped trying.

If you’re interested in the Canadian REIT sector, this recap from Koneko Research is an excellent read. He breaks down the whole sector, including some interesting names.

One more thing!

I’m always looking for feedback, and I really enjoy hearing from readers. If you can think of any ideas to improve Canadian Dividend Investing, or if there’s something you want to see more of, or if there’s something you hate, please, let me know. Hit reply and say hello — I’d love to hear from you.

And, as always, thanks for reading. There are thousands of you out there who read this newsletter each week, and I’m always incredibly humbled by that.