The pros and cons of discounted dividend models

Two months ago I wrote a long article about Discounted Dividend Models and how I’ve started to use them to value companies.

I then added a template to my investment spreadsheet so I could quickly build a standardised dividend model for any company which I could then refine and expand upon later.

After that I spent several weeks hammering out one dividend model after another so that I now have reasonably detailed models for all of my portfolio‘s 30 or so holdings.

As I now have a lot more experience of what it takes to build discounted dividend models in the real world, I thought it would be useful to outline some of the major pros and cons I’ve run into while using this approach.

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How to value shares with a Dividend Discount Model

As a value investor, I’ve spent most of the last ten years valuing companies using valuation ratios such as dividend yield and the cyclically adjusted price-to-earnings ratio (CAPE or PE10).

However, I now think such backward-looking ratios are inferior to the more theoretically correct Dividend Discount Model (DDM), which values companies based on an estimate of their future dividends.

So in the rest of this blog post, I’ll explain what the Dividend Discount Model is and how you can use it to guide your buy, sell and position sizing decisions, especially if you’re interested in dividend growth stocks.

Warning: This is a long blog post so you may want to get a cup of tea and a slice of cake before you settle in for a long read. Or, bookmark this page and come back to it when you have a spare moment or three.

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How the UK Value Investor portfolio performed in 2020

With 2020 finally over (good riddance) now is the traditional time for an annual performance review, and who am I to argue with tradition?

In this review I will:

  1. measure my portfolio’s short, medium and long-term performance against an appropriate benchmark and 
  2. think about what went right and what went wrong, and how that knowledge can be used to improve future performance
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How to build a concentrated portfolio of quality shares

Value Investing portfolio holdings chart
The 34 holdings in this portfolio is probably too many

Over the last ten years or so my investment approach has moved steadily towards higher quality companies, yet hopefully still purchased at attractive valuations.

This takes quite a bit more time because I have to analyse companies in more detail, but for me this is the right decision as I prefer investing in successful businesses which align with my Quality Defensive Value criteria.

However, during the pandemic, I found that researching potential new holdings for the UK Value Investor portfolio, as well as keeping up to date with its existing 34 holdings, was taking more time than I had available.

I didn’t want to shrink the amount of research I was doing per company, so the obvious solution was to reduce the number of holdings. But reduce it to what?

To answer that we’ll need to look at the following points:

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How to categorise stocks as quality, defensive and/or value

Quality Defensive Value investing

A few months ago I came up with a simple way to categorise companies and their shares based on their most important attributes.

For me, those most important attributes are Quality, Defensiveness and Value, so in this article I’ll outline how you can find out if a company is Quality, Defensive and/or good Value, and how you can combine these factors to categorise a wide variety of stocks.

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Sold: Dunelm’s share price is too high for my liking

Dunelm share price chart


  • Dunelm is a high quality, highly profitable business with durable competitive advantages. It’s the UK’s leading homewares retailer.
  • Dunelm is not a defensive business, but it does operate in a growing market and uses relatively little financial leverage for a retailer.
  • Dunelm has performed very well during the pandemic and its shares have performed even better.
  • I still like the business, but after recent share price gains I think its valuation and dividend yield are no longer attractive.
  • I recently sold all my Dunelm shares having owned them since 2016.

“Dunelm is market leader in the £14bn UK homewares market and active in the £12bn UK furniture market. It currently operates 173 stores, of which the majority are out-of-town, and trades online through”
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These are my best and worst performing stocks through the pandemic (so far)

The world has been turned upside down by this pandemic, along with the prospects of many companies.

Perhaps some of your own holdings have soared to unexpected highs, or collapsed to unexpected lows.

Several of my holdings certainly have.

However, don’t pat yourself on the back or don a dunce cap too soon.

In most cases, these dramatic moves are mostly down to luck, both good and bad.

As an example let’s take Dunelm and WH Smith.

Respectively these are the best and worst performing retailers in my portfolio so far in 2020 (ignoring Ted Baker, which I’ve already sold).

Before the pandemic I thought they had broadly similar prospects, with Dunelm performing well as the UK’s leading homewares retailer and WH Smith with an impressive travel retail business.

But since the pandemic began their fortunes have gone in wildly different directions.

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Selling Xaar: Why heavy R&D and high cyclicality are not a good mix


  • Xaar is a relatively young and small leading-edge technology business which I bought in mid-2018
  • It’s a good example of how excessive R&D in highly cyclical businesses can produce bad results
  • I sold because a 90% increase in Xaar’s share price since November means the company is no longer obviously cheap
  • Although Xaar was a bad investment it has helped me define the boundaries of my comfort zone, which is defensive value stocks
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Jupiter AM: A good business but is it a good investment?

In this 4,000-word investment review I look at Jupiter Fund Management PLC, a self-described high conviction active asset manager.

  • Jupiter is a leading active fund manager focused on equity funds for UK retail investors sold through financial advisers
  • Assets under management have grown fairly consistently for most of the last 35 years
  • Profitability is high, even among fund managers where high returns on capital are fairly common
  • Jupiter recently made a large acquisition to increase fund diversity and economies of scale
  • At 212p Jupiter’s dividend yield is above 8%, largely due to the pandemic and declining assets over the last two years
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Why Ted Baker has been a disaster and a gift in equal measure

Any investment which loses more than 95% of its value can only be described as a disaster. However, the lessons learned from this disaster are so powerful I would have to describe Ted Baker as a gift, albeit a painful one.

Key points

  • Ted Baker produced consistent, rapid growth for many years
  • Ted’s growth was largely funded by banks and landlords rather than shareholders
  • External funding was used to drive growth because of Ted’s weak profitability
  • Even before the pandemic, Ted had more debt and leases than it could comfortably afford.
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How to find quality companies producing consistent and sustainable growth

This article outlines how I look for quality companies capable of producing consistent and sustainable growth over long periods of time.

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Tips for investing in a coronavirus world

This article covers some investing tips based on adjustments I’ve made to my defensive value investment strategy in response to the coronavirus pandemic.

So far this pandemic-driven downturn is nothing like a normal recession.

With high-quality companies suspending their dividends left, right and centre, the economic consequences of coronavirus are much more sector specific and much more devastating than we would normally see.

As a result, I’m sure that many investors have had to re-think their approach to buying and selling stocks as they attempt to minimise risks and maximise returns from their portfolios.

I’m no different. Over the last couple of months, I’ve made a few minor adjustments to my “defensive value” investment process which, I hope, will steer my portfolio through the storm and leave it well positioned on the other side.

These adjustments are based on sensible principles and I think they’ll apply to a wide range of investors.

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The S&P 500’s CAPE ratio says the US is still expensive

In this article I look at the S&P 500’s response to the coronavirus pandemic, the impact on CAPE valuations and what that means for the index’s expected ten-year returns.

The world is in the grip of a rapidly expanding pandemic and countries around the world have shut down large parts of their economies and told citizens not to go outside.

The International Monetary Fund (IMF) now expects a global recession far worse than the one that followed the financial crisis and worse than any since the great depression.

Companies left, right and centre are suspending dividends and reporting revenue declines of more than 80%.

And yet despite the obvious damage being done to the global economy, the S&P 500 is not even in bear market territory.

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The potential impact of coronavirus on dividends

Investors who rely on dividends for a large part of their income should prepare for significant dividend cuts and suspensions in 2020.

In recent weeks, stock markets around the world have crashed as a direct result of the coronavirus pandemic.

In most corrections and market crashes, dividend investors are able to shrug off paper losses and focus on what really matters; their reliable stream of dividend payments.

But in the current crisis that may not be so easy.

The limitations on free movement of people and goods being put in place to slow the spread of the virus will have (and are already beginning to have) a significantly negative impact on the ability of most companies to generate the cash they need to pay dividends.

Already we’ve seen dividend suspensions from Marks & Spencer, Kingfisher (B&Q and Screwfix), Weatherspoons, ITV, Stagecoach and many more.

So how bad could it get? Of course we don’t know, but history may provide us with a few clues.

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