In the December issue, we announced that the strong performance of the Dividend Champions Portfolio had prompted us to discontinue the Legacy Portfolio. This will also simplify stock selection for subscribers since all of our current recommendations are now represented by a single portfolio.

However, we know that many subscribers still hold some of the stocks from the Legacy Portfolio. As such, we’ll continue to monitor those former holdings that meet our stringent Dividend Champions criteria, as well as a few others whose coverage has specifically been requested by subscribers.

These names are now included in the Portfolio Watch List, which is also available on our website. If there are other former recommendations that you would like to have monitored, please let us know by posting a comment to the “Stock Talk” page at our website.

The criteria that we use to select the Dividend Champions are explained below. We apply the same criteria to the companies that we track on the Portfolio Watch List and provide a Quality Score that ranges from 0 to 5 (with 5 being the best). The Quality Score indicates the likelihood that a company can sustain and grow its dividend over time.

1) A track record of consistent and growing dividend payments: Does the company have a track record of consistent and growing dividend payments over time? We look for a company that has been paying dividends for at least five years, but preferably much longer.

2) A rock-solid balance sheet: Does the company carry high levels of debt that could constrain future dividend payments? Generally speaking, we look for companies with a debt-to-capital ratio of less than 50% and with interest coverage of more than three times.

3) A payout ratio that leaves room for unforeseen events: We prefer companies whose dividend obligations are manageable, thus allowing them to sustain their payouts when times get tough. Here, the cyclicality of a company’s business is an important consideration. Beyond that, we look for companies whose payout ratios are less than 70% of free cash flow (operating cash flow minus maintenance capital expenditures).

4) Prospects to grow the dividend faster than the rate of inflation: A company that is unable to grow its dividend faster than the rate of inflation for an extended period is unlikely to provide an acceptable total return.

5) An attractive starting dividend yield and a reasonable valuation: Apart from the dividend yield, we are also looking for a reasonable valuation based on metrics appropriate for the business. In the present environment, that means we’re looking for companies whose stocks yield 2.5% to 5% and whose payouts are projected to grow 5% to 10% annually.

With these criteria in mind, please review our watch list to see the stocks that we’re monitoring for potential inclusion in the Dividend Champions Portfolio.