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“Invert. Always invert.” — Friend of the newsletter Charlie Munger

The art of stock market research can be as simple or as complicated as you make it out to be. For instance, I’ve easily had a hundred investors reach out to me over the years to admit that they bought a stock I mentioned briefly in a Twitter post.

I wish I was exaggerating, but it’s true. And that’s just the ones that have told me. There are probably hundreds more.

That’s the lazy way out, and needless to say it’s not recommended.

On the other side of the spectrum we have folks who will do nothing but research a company for weeks. They tune out all other responsibilities and dig as deep as possible into the name, not satisfied until they find out the CFO’s favourite M&M colour is green and his daughter is currently a sophomore at Vasser — where she’s studying child psychology.

Don’t worry, the analyst didn’t follow her Instagram. That would be creepy.

There are problems with both extremes. The issues with the former are pretty obvious, but I still think the latter is also problematic. Researching too deeply creates a different kind of bias. There’s comfort in knowing things down to the smallest detail, and it’s unlikely somebody is going to abandon their thesis after doing that much work. It creates a form of confirmation bias, no matter how much one might protest otherwise.

Today on the newsletter I’m going to talk about a third way of researching, something a little unusual. We’re going to invert our thinking and reverse engineer the perfect dividend stock.

How exactly do you reverse engineer a stock, anyway?

The typical research process is a bottom-up approach. You pick a stock and check out its fundamentals, valuation, growth potential, management, and any number of about 9,000 other variables.

It’s exactly what we do on the premium edition of the newsletter — each and every Tuesday.

The only limit is how deep you want to dig. I prefer what I call medium dives — research that identifies the main movers behind the stock and some detail on those — but doesn’t get too far into the weeds.

I prefer this because those are the factors that are going to move the stock.

Let’s use Allied Properties REIT (TSX:AP.un) as an example. You can dig as deeply as you want on this one, but ultimately it’s going to trade based on:

• The portfolio’s occupancy

• Rental growth (or lack thereof)

• General thoughts on the health of the office market in Canada

The details don’t really matter. What matters is getting those three things right.

Reverse engineering is the exact opposite. Instead of looking for specific stocks first, you’d look for specific attributes first. You’d make a list, check it twice, and then figure out stocks that checked off those boxes. Only after that point would you start the research process.

The process is going to be slightly different for everyone, since we’re all looking for different things. Some of you are younger and prioritize growth with your dividends, so you might look for something with a minimum of 8% dividend growth. Retirees might want more yield and less growth, and so they’d potentially set a criteria of 5% yield with 3% growth.

And so on. There are a million possibilities.

The list doesn’t need to focus on dividend growth, either. You might use something like the Buffett method, which focuses more on valuation with a growth variable added on after that. It doesn’t worry about dividends at all.

Once you’ve identified the list, then it’s time to research the companies. Since I’ve already researched most dividend stocks of any size in Canada, I won’t spend much time on the process. I mostly use it as a time to reacquaint myself with a stocks that make the list.

This might remind y’all of screening, but it’s not quite the same thing. For those of you unaware, a stock screen is something investors use to identify stocks with certain characteristics. Some might look for low P/E ratios; others might identify stocks with low EBITDA-to-debt ratios. Some might sort by market cap, allowing small-cap investors to ignore larger stocks. Or vise-versa for those who only want to own large companies.

Our exercise today is a little different than screens because I find screens to be too restrictive. For example, if I’m looking for a stock with 8% dividend growth and ask a screen to pull that up based on a stock’s history, that screen is going to miss everything that has offered a 5-7.99% dividend growth rate.

We don’t want that. That’s too restrictive.

Essentially, reverse engineering the process takes us back to the thing that really matters — our goals. That’s the beauty of this exercise.

Reverse engineering a high yield, high dividend growth stock

Let’s look at a concrete example.

Even though conventional wisdom says that high dividend yields and decent dividend growth don’t go together, I believe investors can get both. They just have to be patient.

The first step is to identify a list of the stocks that meet your criteria. If very few (or none) exist, you have two options. You can either relax your criteria or wait until the next bear market to buy ‘em on the cheap.

For instance, Capital Power (TSX:CPX) just announced a 6% dividend raise. That’s growth of nearly 200% more than the posted inflation rate, which is good news for a retiree looking to live on that income stream. It’s growing faster than their spending.

But while Capital Power delivers on the dividend growth part, the yield part is a little lacking. The current dividend is a little less than 5%, and that’s after sitting in the 6-7% range for years.

If we’re reverse engineering a dividend stock that offers a 5% yield and 5% growth — which I think is at the achievable level today — then you’d have relax the rules a little bit to have Capital Power make the list. But it’s close enough that I think we can include it — even though the yield is only 4.7% today.

But if you were adamant that you needed a 7% yield to go with the 5% growth, then it’s not going to make it. Capital Power just doesn’t cut it.

Here are a few more stocks that I would include in 5% yield/5% dividend growth list:

• Algoma Central (TSX:ALC) — I wrote about Algoma here

• Bank of Nova Scotia (TSX:BNS)

• Brookfield Infrastructure Partners (TSX:BIP.un)

• Brookfield Renewable Partners (TSX:BEP.un)

• Cogeco Communications (TSX:CCA)

• Enghouse Systems (TSX:ENGH)

• Granite REIT (TSX:GRT.un)

• Pembina Pipeline (TSX:PPL)

• Telus (TSX:T)

You could squint and put a few more names on the list. For instance, Great-West Life (TSX:GWO) offers a 4.6% yield as I write this, with recent dividend growth in the 6-7% range. But it’s almost 10% under our starting yield, so let’s not. It’s just too far away.

It’s slim pickings right now

The TSX Composite is bumping up against all-time highs these days, with a lot of high-yield dividend stocks also at multi-year highs.

Just a few months ago during Trump’s tariff tantrum, it was a whole different ball game. A patient investor could’ve added some of these at 6-7% yields, rather than 5% yields. For instance, Capital Power shares fell to $44 each. That’s a 5.9% yield, rather than the 4.7% yield offered today. That’s 20% more yield simply by being patient and waiting.

That’s the beauty of the reverse engineering process. You don’t need to compromise what you’re looking for. You can simply wait for the market to come to you.

You might be waiting a very long time if you have unrealistic expectations, but I doubt most people are that patient. They’ll either reset expectations to reality or go try and find another market.

The important thing is to stick to your guns. If the market doesn’t cooperate and give you want you want, then it’s fine to sit in cash for a little while. There are generally a few sell-offs per year, so chances are you won’t be waiting that long.

The bottom line

Remember, there’s no such thing as the perfect dividend stock. Each investor has different goals and is looking for a slightly different outcome than you are. So there’s only the perfect dividend stock… for you.

By identifying what you’re looking for beforehand and only then trying to find stocks that match the criteria, we’re constantly reminded of what really matters. It isn’t beating an index, nor is it ending up with more money than your friend (or rival).

No, the important thing is reaching your goals. For many people reading this I suspect your goals are to create a sustainable dividend portfolio that will someday fund your retirement.

If stocks are available that meet that criteria, great. And if not, it’s okay to wait. Patiently building up cash isn’t such a bad thing — especially if you have the bulk of your net worth already invested. The only thing better than buying income is buying more income for the same price.