In the December issue, we announced that we had discontinued the Legacy Portfolio. This simplifies 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 criteria, as well as a few others whose coverage has specifically been requested by subscribers.

These names are now included in the Income Portfolio Watchlist. 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.

The Safety Rating System criteria that we use for stock selection are explained below. We apply the same criteria to the companies that we track on our Watchlist.

Safety Ratings gauge the safety and sustainability of the dividend and are not intended as a measure of value. The system awards points for fulfilling each of eight fundamental criteria, with ratings ranging from 0 (riskiest) to 8 (safest).

In general, more conservative investors should focus on companies with Safety Ratings of 4 and above.

1) Payout Ratio: 

A point is awarded if a company’s payout ratio is within the safety margin for its industry.

2) Growth in Earnings per Share Over Trailing Three-Year Period: 

EPS growth had to exceed industry average to be awarded a point. This threshold helps ensure proper dividend coverage, while offering the potential for dividend growth.

3) Debt to Assets: 

Companies get a point if debt as a percentage of assets is below the safety margin for their sector.

4) Debt-to-Market Capitalization:

A point is awarded if long-term debt as a percentage of market capitalization is below the industry average. This measure seeks firms that are least indebted as compared to their market capitalization, as they are typically more stable investments.

5) Altman Z-Score: 

Used to determine revenue reliability, this metric is the most accurate predictor of bankruptcy within a two-year period. A point is awarded for passing one of the financial world’s most rigorous solvency metrics.

6) Dividend Growth Over Trailing Five-Year Period: 

A point is awarded to companies that were able to grow their dividends at a pace that exceeded the industry average over the trailing five-year period.

7) Total Debt to EBITDA:

A point is awarded to firms that have low debt relative to the size of their earnings. A firm’s ability to pay down debt is directly related to earnings before interest, taxation, depreciation, and amortization (EBITDA). The long-term solvency of a firm and its ability to pay a dividend are dependent on earnings to pay future obligations.

8) Free Cash Flow Per Share:

A point is awarded for steady growth in free cash flow because it’s a much more accurate measure of how much cash a business actually has to service debt, pay dividends, invest in operations, or buy back shares.

The Safety Rating System’s criteria vary somewhat from sector to sector to allow for differences in fundamentals.

Note that companies with low Safety Ratings can still rate buys for aggressive investors if there’s sufficient upside potential. Conversely, companies with high Safety Ratings can actually be sells if they trade significantly in excess of fair value.

With these criteria in mind, our Income Portfolio Watchlist shows the stocks that we’re monitoring for potential inclusion in the Income Portfolio.