I spend a lot of time working for clarity on how to assess whether I'm doing ok with a given investment or with the entire portfolio of holdings that I have within my retirement portfolio.
A thought just came to me regarding how one might think about the situation conceptually.
First; one should ask; at what rate is inflation eroding the purchasing power of my wealth. Whatever my investments, they must make headway against inflation, or I am effectively in a savings account without a return on investment.
Second, is the company in which I am invested growing it's business or not? Did it produce more revenue this year than last year? Did it produce more profits this year than last year? Did it produce more than the rate of inflation?
Third: What about my position with that company? Did my position grow slower, the same or faster than the growth of the company? Is my investment in the company compounding or not?
Very simply, if the value of a position grows less than the rate of inflation, one is in a losing investment. If the portfolio value grows less than the rate of inflation, one is in a losing portfolio.
Since my focus is primarily on producing a rising stream of income on which I will eventually live, valuation is a secondary issue to cash flow. It is possible for a portfolio to produce increasing cash flow even as it's value is declining, stagnant or growing at a rate lower than inflation, but only for a while. Eventually, there must be rising earnings in order to support rising dividends. There should be growth in valuation as a consequence of those rising earnings.
So, this thought is about how one monitors a holding, or the entire portfolio.
Start with the overall cash value of the portfolio. Has it increased on a year to year basis? If new money is coming in, then that must be subtracted in order to see the investment performance.
Second, what about each holding? Has the position grown in value? If not, what about the income stream? by how much? less or more than inflation?
Finally, what about relative performance? If one's best efforts are not as good as a well constructed dividend producing ETF or mutual fund, then why expend the effort at managing one's own portfolio. Time is money, or even better; time is the one equity that cannot be purchased with money. Time expended should deliver significant value or it should be spent on something else than managing a portfolio.
So, how am I doing? Good question; let's look.
4/30/2013 12/31/2013 12/31/2014
Trad 797743 815164 912752
Roth 136897 143127 138412
Trad div 20895 23619 25612
(12mo est)
Roth div 6117 6215 5938
(12mo est)
What happened? In my roth account in 2013, I succumbed to some speculative temptations; lost a bunch of money in battery storage and biotech companies that did not have positive earnings or dividends. I actually sold some dividend-paying stock that I wasn't interested in and blew it on speculation. I decided I wouldn't do that again, so I sold out after the losses, reinvested what remained back into more conservative holdings.
I have a Schwab 401k account. It includes both Roth and traditional components, but it looks like one account. I can't break out the percentage of one from the other at the moment, with current reporting. That is an actively growing account, with pension and profit sharing contributions. It is a "smaller cap" DGI portfolio, but I'm rethinking that strategy at this point. I can hold small- and medium-cap companies in any of my accounts and it really doesn't matter in the long run. For the sake of clarity, it may be easier to segregate types of holdings in one account. I'll be thinking abut that in upcoming days...
Monday, March 2, 2015
Sunday, February 22, 2015
Illustrating the DRIP
I have chosen to use the dividend reinvestment plan through my discount broker to reinvest dividends in my retirement plan holdings. I choose to do so for simplicity and because I am making my performance bet on the entire portfolio, rather than on discerning the "best value" component on a quarter to quarter basis.
From an income growth perspective, it's not immediately apparent which holdings produce the most robust dividend growth if one is watching what the broker delivers in the monthly investment report, which is primarily about the value of the overall portfolio and of each position.
I have tabulated the actual dividend payments over time from a few of my holdings to illustrate the amount of actual dividend growth that I have experienced over the holding period.
WMT
In 2011 I purchased 200 shares of WMT for $10,884.30
Over the next 4 quarters I received $323.11 in dividends with which I purchased 5.424 shares
Over the next 4 quarters I received $360.26 in dividends with which I purcahsed 4.908 shares
Over the next 4 quarters I received $403.44 in dividends with which I purchased 5.322 shares
My cost per share increased from $55.05 to $75.74 per share in that interval. Dividends received in the last year were 24.9% higher than the first year. Examining the actual payments shows that each yearly payment was a bit over 10% higher than the prior year. Dividend reinvestment accounts for just under 3% of the yearly dividend growth, and dividend increases account for the remainder. My share count increased by 7.8% over 3 years.
MCD
In November 2010, I purchased 150 shares of MCD for $10,723.90.
Over the next 4 quarters I received $374.14 in dividends with which I purchased 4.674 shares.
Over the next 4 quarters, I received $442.23 in dividends with which I purchased 4.76 shares.
Over the next 4 quarters, I received $501.92 in dividends with which I purchased 5.23 shares.
Over the next 4 quarters I received $545.25 in dividends with which I purchased 5.633 shares.
My cost per share increased from $67.95 to a high of $100.65 during that interval.
The number of shares purchased each year increased and the last year's dividends were 45.3% higher than the first year, demonstrating dividend growth of about 11% per year. Dividend reinvestment accounts for about 3% annual increase in dividends and dividend increases account for the remainder.
My share count increased by 13.5% over 4 years.
JNJ
In 2009 I purchased 203 shares of JNJ for about $11,715.
Over the next 4 quarters I received $431.41 in dividends, with which I purchased 7.035 shares.
Over the next 4 quarters I received $481.26 in dividends, with which I purchased 7.569 shares
Over the next 4 quarters I received $529.93 in dividends, with which I purchased 8.161 shares
Over the next 4 quarters I received $590.75 in dividends, with which I purchased 7.444 shares
Over the next 4 quarters, I received $651.88 in dividends, with which I purchased 6.638 shares
My cost per share increased from $60.90 to $103.96 in that interval. The number of shares purchased varied from year to year, and clearly effected by the rising share price in the latter two years. The last year's dividends were 51.1% higher than the first year, demonstrating a dividend growth of about 10.2% over that interval. Dividend reinvestment accounts for 3% of the annual dividend growth and dividend increases account for the remainder. My share count increased by 18.2% over 5 years.
I don't have the patience to repeat this for each of my retirement holdings, but these examples demonstrate that investing in blue-chip dividend-paying companies with a history of raising dividends and following a dividend reinvestment plan can result in actual growth in income approaching 10% per year. These examples are not companies with torrid earnings growth OR dividend growth rates, They are mature companies with moderate growth rates and substantial dividend payments. However, with dividend reinvestment, they produce adequate cash income growth within the position that a doubling of that income every 7-10 years is easily within reach. Given the strong disincentive for companies such as these to cut dividends, the rising income is relatively reliable, even if earnings are more variable and the stock price is volatile. While rising earnings will tend to boost both stock price AND dividends, even stagnant earnings can still yield a rising income as dividends are reinvested, as well as through dividend increases which sometimes happen even in a stagnant earnings environment. When one chooses to take a distribution from the payments, the rate of growth in income will slow, but it should still be possible to see the portfolio keep pace with inflation if inflation stays within reasonable bounds. I'm hopeful to build a portfolio where a 3% distribution will suffice to meet our maintenance needs. Other writers have demonstrated that this is possible.
It's easy to be preoccupied with issues surrounding the purchase and sale of blocks of stocks, where one must pay close attention to valuation in order to achieve reasonable investment returns over time. Once that purchase is complete however, a DRIP program allows you to average into a larger position over time, adding shares in times of both lower and higher valuation, resulting in an overall favorable entry point over time. Using a DRIP, one adds no more than 2-5% to the position in a given year, so it is unlikely that one will make in imprudent decision to purchase a large block of shares just before a price correction or in an emotional response to changing market. It seems to me that the interval between the purchase and eventual sale (which could be never) is where most of the action within the position and the portfolio occurs. It is certainly where the income is generated, unless you enjoy selling stock. For me, buying and selling stock is like buying and selling a house; something to be done carefully and very infrequently. However, I have no problem with adding onto and remodeling the house periodically.
I should reiterate that valuation matters most to the individual who intends to sell some or all of a position to harvest capital gains. Income matters most to the individual who intends to build a cash-producing conglomerate that will continue to spit out increasing cash over time. Rising value is not the income-seeking investor's friend. Increases in valuation are an inevitable consequence of rising earnings and dividends, but not the opposite. Rising value blunts the power of compounding for the income seeking investor.
In order to assure that a dividend growth strategy performs similarly to an equally diligent capital-gains oriented strategy, it's important to take advantage of tax-deferred and tax-exempt vehicles such as the 401k, Roth 401k, IRA and Roth IRA accounts that limit the tax exposure of the investment proceeds over time. The critics of dividend-payments in general have their strongest argument with investments held in after-tax accounts. Fortunately, most of us working stiffs will accumulate the majority of our assets within the bounds of company or individual retirement accounts, blunting the arguments against this strategy.
The examples above demonstrate the potential for one to receive a substantial raise EVERY year with a carefully selected diversified portfolio of dividend-paying stocks. I can assure you that I don't have this opportunity in my daily work, in spite of substantial control over the rate at which I work. If you haven't taken a hard look at the actual growth of cash payments within your DGI portfolio, doing so may give you some comfort about the power of compounding contained within a dividend reinvestment program.
Sunday, February 8, 2015
Taking a hard look at the dividend growth motive
I read about and follow the dividend-growth school of retirement investing. This school of investing espouses purchasing equities with a long history of dividend growth. Devotees of dividend growth investing state their primary interest in creating a portfolio that will produce an ever-increasing stream of income, with which they can pay expenses or re-invest, or both. They claim to be less interested in total return or in capital gains. My problem is that I can't rest completely easily in the new orthodoxy of the dividend growth strategy.
In my heart of hearts, I worry that my dividend-growth strategy won't take me to the place I want to be. In order to have that stream of income, I need a pretty big pot of value. The best performance I can see from folks who post their performance indicates a steady 4% off of the portfolio is possible. I worry that my strategy won't create the big pot of value that I need in the time that need it. At the moment, my portfolio yields about 40k in dividends yearly. At a 10% total return, it will yield 80k in cash when I'm 62 years of age and it will yield 160k when I'm 69 years of age. That doesn't include future investments. If I maximize my pre-tax deferrals for another 10 years, I'll have another $600k in some kind of retirement asset by then, yielding another $24,000 per year at age 65, and another $48,000 at age 72. I guess that should be enough. The government says I should work until I'm 67, so I could put away close to 750k. Actually, I don't see myself working like I do now for another 12 years. If the combined current retirement portfolio assets of my wife and I were to double twice and we could harvest 4% off of it with a high-dividend strategy, there would be about $5 million in assets and $200,000 in yearly income. That's an optimistic estimate, as two doublings before we retire may not happen. Once we start to draw income from the portfolio, the net rate of appreciation will decline substantially. However, we'll contribute another $500k to the effort between now and then, so maybe that target isn't so unreasonable.
So...do I really believe in that strategy? What if I can't earn 10% every year? What if my average is more like 7% per year. that means doubling in 10 years. What if there's a big recession and my portfolio takes a hit like 2008? The best dividend growth companies marched through 2008-9 and never missed a beat with their dividends. Their value plummeted along with the rest of the market, only not so severely. The investor who didn't panic and sell out saw values rebound within a couple of years. I've been doing this long enough now that I'm pretty sure I won't panic and sell out. My biggest risk is simply not getting the investment performance I'm expecting from my dividend growth strategy.
There are still some big expenses ahead of us. My child's private school education is frighteningly expensive. We'll live under a bridge before my wife would sacrifice that experience for him. We'll be on the hook for college between ages 63-67 or so. It may be that inheritance will cover that expense, but no counting chickens...
I'm not counting on SSI, but if it's there when I'm ready to lay down the scalpel, I'll be happy to take it. According to a wise contributor to an investment site I read, SSI should be looked at as the fixed income-portion of one's retirement portfolio; yields about 3-4%, indexes up with inflation, a modest contributor to the whole.
One should ask, what will a couple of old people do with all that money anyway? I'll be surprised if we're hopping around the world at that point. We'll be fortunate to have our health. We'll be fortunate if our son has established himself independently. We'll be lucky if the world is a hospitable place in which to wander around. One thing to acknowledge is that we won't quit working altogether in that interval. I can't imagine taking a traditional retirement. What we'll need to do is cover our expenses.
I'm pretty certain I couldn't capitulate and go back to fund, or fund of funds, or capital-gains investing. I fret enough as it is about capital value of my holdings, even knowing the dividend reinvestment is at work. I haven't completely abandoned the old me. So, I'll trudge along with this strategy and hope that eventually the hyper-vigilance will go away and I'll trust more fully in the process.
So, I guess I'm committed, since I can more easily see 3-4% dividends reinvested, along with 5-7% capital appreciation leading to a 10% total return on investment over the long haul, than hoping for higher capital gains and eventually converting to a "harvesting" regimen. If it only makes 7% per year, I can still get to a comfortable place where most or all of my wages are replaced by investment earnings.
In my heart of hearts, I worry that my dividend-growth strategy won't take me to the place I want to be. In order to have that stream of income, I need a pretty big pot of value. The best performance I can see from folks who post their performance indicates a steady 4% off of the portfolio is possible. I worry that my strategy won't create the big pot of value that I need in the time that need it. At the moment, my portfolio yields about 40k in dividends yearly. At a 10% total return, it will yield 80k in cash when I'm 62 years of age and it will yield 160k when I'm 69 years of age. That doesn't include future investments. If I maximize my pre-tax deferrals for another 10 years, I'll have another $600k in some kind of retirement asset by then, yielding another $24,000 per year at age 65, and another $48,000 at age 72. I guess that should be enough. The government says I should work until I'm 67, so I could put away close to 750k. Actually, I don't see myself working like I do now for another 12 years. If the combined current retirement portfolio assets of my wife and I were to double twice and we could harvest 4% off of it with a high-dividend strategy, there would be about $5 million in assets and $200,000 in yearly income. That's an optimistic estimate, as two doublings before we retire may not happen. Once we start to draw income from the portfolio, the net rate of appreciation will decline substantially. However, we'll contribute another $500k to the effort between now and then, so maybe that target isn't so unreasonable.
So...do I really believe in that strategy? What if I can't earn 10% every year? What if my average is more like 7% per year. that means doubling in 10 years. What if there's a big recession and my portfolio takes a hit like 2008? The best dividend growth companies marched through 2008-9 and never missed a beat with their dividends. Their value plummeted along with the rest of the market, only not so severely. The investor who didn't panic and sell out saw values rebound within a couple of years. I've been doing this long enough now that I'm pretty sure I won't panic and sell out. My biggest risk is simply not getting the investment performance I'm expecting from my dividend growth strategy.
There are still some big expenses ahead of us. My child's private school education is frighteningly expensive. We'll live under a bridge before my wife would sacrifice that experience for him. We'll be on the hook for college between ages 63-67 or so. It may be that inheritance will cover that expense, but no counting chickens...
I'm not counting on SSI, but if it's there when I'm ready to lay down the scalpel, I'll be happy to take it. According to a wise contributor to an investment site I read, SSI should be looked at as the fixed income-portion of one's retirement portfolio; yields about 3-4%, indexes up with inflation, a modest contributor to the whole.
One should ask, what will a couple of old people do with all that money anyway? I'll be surprised if we're hopping around the world at that point. We'll be fortunate to have our health. We'll be fortunate if our son has established himself independently. We'll be lucky if the world is a hospitable place in which to wander around. One thing to acknowledge is that we won't quit working altogether in that interval. I can't imagine taking a traditional retirement. What we'll need to do is cover our expenses.
I'm pretty certain I couldn't capitulate and go back to fund, or fund of funds, or capital-gains investing. I fret enough as it is about capital value of my holdings, even knowing the dividend reinvestment is at work. I haven't completely abandoned the old me. So, I'll trudge along with this strategy and hope that eventually the hyper-vigilance will go away and I'll trust more fully in the process.
So, I guess I'm committed, since I can more easily see 3-4% dividends reinvested, along with 5-7% capital appreciation leading to a 10% total return on investment over the long haul, than hoping for higher capital gains and eventually converting to a "harvesting" regimen. If it only makes 7% per year, I can still get to a comfortable place where most or all of my wages are replaced by investment earnings.
Saturday, January 31, 2015
Where's the forest amongst all these trees?
Is it good times or bad? Are we in recovery or on the brink of the next world-wide financial crisis? Certainly there are crises of all manner at our fingertips in the news.
Here we are in earnings season again. The market is choppy; up 1%, down 2%, up another 1%, down 1.5%. Companies reporting record earnings, missing estimates. Which is it...good or bad? Dividend increases, soft guidance. Perhaps a pattern is emerging; Record earnings, soft guidance leads to a "earnings beat" and higher valuation the next quarter. Valuations remain high, and I'm starting to see some pundits talk like there's a "new normal". You know what happened the last time people were talking that way. The problem is, if there weren't traders, there wouldn't be a market. Can you imagine a day in the stock market where everyone just stayed home, because they didn't like the prices? Still, I'm DRIPing my way to fully invested, allowing my cost basis to ratchet up bit by bit, Am I foolish? I hate cash sitting there, not working. I also think that a few fractional shares, purchased at higher valuation, will be balanced sooner or later by some shares purchased at depressed valuation, and the share count will keep growing. I like that compounding, even if it's purely the share count. I care about valuation when I have a chunk of cash to invest. I care about valuation at the point I sell shares, which is almost never. I care about valuation if the earnings and dividends are stagnant or dropping, that's for sure. But what about a quarter with soft earnings? What about 2-3 quarters, or even a year? What about McDonalds? What about Coca Cola?
Too much noise...what would happen if I just shut it all off and came back 5 years from now? Leave the DRIPS in place, forget about balancing, just wander off and do something more interesting and find out what's still standing 5 years from now.
I thought there was a bolus of new cash coming into the retirement portfolio. I finally figured out where to look and my last year's contributions are complete. So, I can go back to worrying about what's in there, not what to buy next. Back to watching the ticker, as if I could ever stop. Back to watching those dividends hit the account. Back to sitting on my hands.
Here we are in earnings season again. The market is choppy; up 1%, down 2%, up another 1%, down 1.5%. Companies reporting record earnings, missing estimates. Which is it...good or bad? Dividend increases, soft guidance. Perhaps a pattern is emerging; Record earnings, soft guidance leads to a "earnings beat" and higher valuation the next quarter. Valuations remain high, and I'm starting to see some pundits talk like there's a "new normal". You know what happened the last time people were talking that way. The problem is, if there weren't traders, there wouldn't be a market. Can you imagine a day in the stock market where everyone just stayed home, because they didn't like the prices? Still, I'm DRIPing my way to fully invested, allowing my cost basis to ratchet up bit by bit, Am I foolish? I hate cash sitting there, not working. I also think that a few fractional shares, purchased at higher valuation, will be balanced sooner or later by some shares purchased at depressed valuation, and the share count will keep growing. I like that compounding, even if it's purely the share count. I care about valuation when I have a chunk of cash to invest. I care about valuation at the point I sell shares, which is almost never. I care about valuation if the earnings and dividends are stagnant or dropping, that's for sure. But what about a quarter with soft earnings? What about 2-3 quarters, or even a year? What about McDonalds? What about Coca Cola?
Too much noise...what would happen if I just shut it all off and came back 5 years from now? Leave the DRIPS in place, forget about balancing, just wander off and do something more interesting and find out what's still standing 5 years from now.
I thought there was a bolus of new cash coming into the retirement portfolio. I finally figured out where to look and my last year's contributions are complete. So, I can go back to worrying about what's in there, not what to buy next. Back to watching the ticker, as if I could ever stop. Back to watching those dividends hit the account. Back to sitting on my hands.
Saturday, January 10, 2015
Stock for sale
Selling...
Sell; a bad word, one I'd prefer to avoid uttering. No one wants to talk about selling stock. The few, the brave, tackle it now and again.
Why is it a bad word? Well, if you sell you may realize gains, or not. If so, it may be a tax generating move. If you sell at a loss, you've lost. Bad choice, unforeseen circumstance, incomplete data set; something, but still a loss and the regret of not foreseeing what was coming.If you sell because you need cash, you reduce the size of your engine. If you sell to rebalance, you're probably cashing in a winner, rotating from your faster horse to a slower one. If you sell an "overvalued" stock, you are obligated to have an idea in mind for where you'll invest that cash. We all know cash is slowly losing against inflation.
So, I'm not predisposed to sell stock. The Oracle himself said that his ideal holding period is forever.
Some very smart older investors in the pages I read say sell never, or rarely. I like that advice, because it relieves me of the concern that there will be many of the circumstances that warrant serious consideration of selling shares. It also tells me that the one of the key factors in avoiding the need to sell a stock is the nature of the decision to buy in the first place.
Investors have different names for their foundational holdings. Core stocks, "forever stocks", high conviction stocks, widows and orphans stocks are all names applied to the ones you intend to buy and never sell. Food never goes out of style and never is made obsolete by advances in technology. Toilet paper and toothpaste appear to have the same qualities. Electricity, water, telecommunications are similar in eternal necessity and appeal. In the last century, this one and perhaps the next, petroleum products seem to be similarly necessary, although supply, demand and prices can be pretty volatile. Buildings to house ourselves and our businesses appear to be a very stable place to invest, in general.
With a bit of attention to detail, purchase of such companies comes down purely to a "at what price" decision. The proverbial "margin of safety" fairly quickly gives one room to tolerate a significant downdraft and still have an asset the performs well over the long haul, and throws off cash on which you can live. Once purchased, you can basically forget about them, reinvest dividends until you need them, and rest assured that they will be there far longer than you will, continuing to generate income.
Many investors have another class of stocks that are not core, but are still considered to be long term holds for capital appreciation, income or both. Technology stocks are often thrown into this category. One doesn't know if they will be around 30 years from now or in what form, but in the intermediate term future they appear to be vital to our economy and are pumping out lots of cash. Many cyclical industrial stocks fit into this category. Again, the purchase decision is the key decision, and selling is either based on a target amount of appreciation, the end of a business cycle or some kind of horrible disruption that couldn't be anticipated.
Finally, there are the speculative investments. No earnings, no income, lots of potential growth, but who knows if they will be the winner or a competitor will leave them in the dust. Here's the problem; they are by nature volatile, the story may take many years to play out, and one may see paper losses long before being ready to take gains. I've learned that this kind of investing just gives me too much heartburn and it's not for me. So rather than worry when to sell, I just won't buy in the first place.
So what about those other "sell rules"? What about flattening of the earnings curve? What about declining rate of dividend growth, freeze or cut? What about "fundamental changes in the business"?
I don't have adequate experience in exercising these sell rules, so the best I can say is that I'll look at each of these on a case to case basis, hope that I hear the rumors before the facts occur on the ground and hope I don't show up too late to the "sell" party, when the losses have already been severe.
Since the reasons for "crisis selling" are infrequent and I am holding somewhere around 50 ownership positions, I can withstand a 50% loss in one position with a mere 1% effect on the overall portfolio value; roughly the dividend payout of a single quarter for my portfolio. That is the value of diversification.
One thing I'm learning about stocks that lose a lot of value; the reason they lost the value is generally the same reason they aren't likely to roar back to even, unless they are a victim of a smear campaign or some market irrationality. If the reasons are internal to the management, sales or earnings, then one is best choosing another horse to ride back to the barn. That's where the cold, emotion-free, attachment-free, no-pride attitude comes in. No basketball player I know shoots 100%.
After a missed shot, they come back and shoot again. In investing, the missed shot has to be completed by a "sell". Otherwise, that piece of the game just comes to a halt. I am amazed at how quickly the "hurt" in a loss goes away after you turn it into cash. When it hurts most is while you are holding that depreciated asset, hoping things will magically turn around and roar back like your original thesis foretold.
I've begun to pay more attention to what the most mature voices I read call "quality" in companies. Some use credit ratings on debt as a metric for quality. They also depend on the duration of the dividend and earnings history, payout ratio and other indications of safety of the dividend. Given that dividend freezes, cuts and suspensions all are value killers, it makes sense to focus on dividend coverage for those companies that make a point of paying significant dividends. Since those are the companies I like to buy, I'm going to start paying more attention to how one distinguishes quality in the earnings/dividends and debt rating. Then that ugly "sell" word won't need uttering very often.
Sell; a bad word, one I'd prefer to avoid uttering. No one wants to talk about selling stock. The few, the brave, tackle it now and again.
Why is it a bad word? Well, if you sell you may realize gains, or not. If so, it may be a tax generating move. If you sell at a loss, you've lost. Bad choice, unforeseen circumstance, incomplete data set; something, but still a loss and the regret of not foreseeing what was coming.If you sell because you need cash, you reduce the size of your engine. If you sell to rebalance, you're probably cashing in a winner, rotating from your faster horse to a slower one. If you sell an "overvalued" stock, you are obligated to have an idea in mind for where you'll invest that cash. We all know cash is slowly losing against inflation.
So, I'm not predisposed to sell stock. The Oracle himself said that his ideal holding period is forever.
Some very smart older investors in the pages I read say sell never, or rarely. I like that advice, because it relieves me of the concern that there will be many of the circumstances that warrant serious consideration of selling shares. It also tells me that the one of the key factors in avoiding the need to sell a stock is the nature of the decision to buy in the first place.
Investors have different names for their foundational holdings. Core stocks, "forever stocks", high conviction stocks, widows and orphans stocks are all names applied to the ones you intend to buy and never sell. Food never goes out of style and never is made obsolete by advances in technology. Toilet paper and toothpaste appear to have the same qualities. Electricity, water, telecommunications are similar in eternal necessity and appeal. In the last century, this one and perhaps the next, petroleum products seem to be similarly necessary, although supply, demand and prices can be pretty volatile. Buildings to house ourselves and our businesses appear to be a very stable place to invest, in general.
With a bit of attention to detail, purchase of such companies comes down purely to a "at what price" decision. The proverbial "margin of safety" fairly quickly gives one room to tolerate a significant downdraft and still have an asset the performs well over the long haul, and throws off cash on which you can live. Once purchased, you can basically forget about them, reinvest dividends until you need them, and rest assured that they will be there far longer than you will, continuing to generate income.
Many investors have another class of stocks that are not core, but are still considered to be long term holds for capital appreciation, income or both. Technology stocks are often thrown into this category. One doesn't know if they will be around 30 years from now or in what form, but in the intermediate term future they appear to be vital to our economy and are pumping out lots of cash. Many cyclical industrial stocks fit into this category. Again, the purchase decision is the key decision, and selling is either based on a target amount of appreciation, the end of a business cycle or some kind of horrible disruption that couldn't be anticipated.
Finally, there are the speculative investments. No earnings, no income, lots of potential growth, but who knows if they will be the winner or a competitor will leave them in the dust. Here's the problem; they are by nature volatile, the story may take many years to play out, and one may see paper losses long before being ready to take gains. I've learned that this kind of investing just gives me too much heartburn and it's not for me. So rather than worry when to sell, I just won't buy in the first place.
So what about those other "sell rules"? What about flattening of the earnings curve? What about declining rate of dividend growth, freeze or cut? What about "fundamental changes in the business"?
I don't have adequate experience in exercising these sell rules, so the best I can say is that I'll look at each of these on a case to case basis, hope that I hear the rumors before the facts occur on the ground and hope I don't show up too late to the "sell" party, when the losses have already been severe.
Since the reasons for "crisis selling" are infrequent and I am holding somewhere around 50 ownership positions, I can withstand a 50% loss in one position with a mere 1% effect on the overall portfolio value; roughly the dividend payout of a single quarter for my portfolio. That is the value of diversification.
One thing I'm learning about stocks that lose a lot of value; the reason they lost the value is generally the same reason they aren't likely to roar back to even, unless they are a victim of a smear campaign or some market irrationality. If the reasons are internal to the management, sales or earnings, then one is best choosing another horse to ride back to the barn. That's where the cold, emotion-free, attachment-free, no-pride attitude comes in. No basketball player I know shoots 100%.
After a missed shot, they come back and shoot again. In investing, the missed shot has to be completed by a "sell". Otherwise, that piece of the game just comes to a halt. I am amazed at how quickly the "hurt" in a loss goes away after you turn it into cash. When it hurts most is while you are holding that depreciated asset, hoping things will magically turn around and roar back like your original thesis foretold.
I've begun to pay more attention to what the most mature voices I read call "quality" in companies. Some use credit ratings on debt as a metric for quality. They also depend on the duration of the dividend and earnings history, payout ratio and other indications of safety of the dividend. Given that dividend freezes, cuts and suspensions all are value killers, it makes sense to focus on dividend coverage for those companies that make a point of paying significant dividends. Since those are the companies I like to buy, I'm going to start paying more attention to how one distinguishes quality in the earnings/dividends and debt rating. Then that ugly "sell" word won't need uttering very often.
Thursday, January 1, 2015
Some ideas on the effect of dividend cuts on one's DG investing fortunes
The average DG investor appears to hold less than/equal to 50 individual equities in his/her portfolio. From the conversations I have monitored here over the years, that seems to be the outer margin of companies that the average individual investor can keep track of.
The early phase of the investor's history is accumulation. That includes accumulation of value, but also accumulation of the portfolio team members. During that phase, most of the attention is paid to performance; earnings growth, capital appreciation, and in the case of the DG investor, rising dividends and cash flow within the portfolio. The "protect your capital" and "protect your income stream" ideas don't seem to be so prominent until one passes through the accumulation phase and into the living-on-distributions phase.
While it is true that a wage earner will not suffer a cash flow crisis as long as the next pay check is coming along, the distinction between accumulation phase and distribution phase from the standpoint of capital preservation is arbitrary. Protecting capital earlier in one's investing history actually has an outsized effect on one's security in the long run, as one is likely to be more vulnerable to discrete losses early in one's investment history. First, there's the experience thing. Second, there's the relative lack of diversification as one builds the number of positions over time. Third, there's the opportunity loss of future earnings if one makes a big mistake with assets that could have 30-40 years to compound if carefully protected.
A dividend cut is a capital killer. It is a symptom of an engine that is failing. Earnings are failing, and the company turns it's resources inwards as it attempts to repair the damage. The company may recover its valuation completely over time but that dividend is your electric bill if you're in the distribution phase.
The investor is faced with a set of challenges; should you do nothing? should you wait and then respond to dividend cuts? Should you anticipate them and attempt to abandon/switch ownership before such an event happens? Avoiding capital losses seems to mandate the anticipate/avoid strategy.
Dividend cuts are always proceeded by something. The company management and board make a decision based on their view of the near term future. They see a threat to earnings, or they have already realized the damage and are now attempting to repair it. They need cash for something other than the dividend. The question is, can you (the owner) anticipate these events and choose to change ownership before the ship hits rough water?
What do you have at your disposal?; You can wait for the announcement of a dividend cut. Problem is, valuation has already taken a big hit by then.
You can look for signs of impending trouble. What might these be?
Deceleration of earnings growth
Deceleration of dividend growth
Rising payout ratio
Rising debt
rising ratio of debt to free cash flow, enterprise value or other similar ratios
Oh boy... that means monitoring. How many data points? How often? what to do with warnings? watch list? sell? what to do with the cash?
Can you innoculate the portfolio against the kind of companies that could face a dividend cut?
credit rating? Payout ratio? Cap on dividend yield?
eyes closing, rounds and surgery on New Year's Day, must pack it in.
The early phase of the investor's history is accumulation. That includes accumulation of value, but also accumulation of the portfolio team members. During that phase, most of the attention is paid to performance; earnings growth, capital appreciation, and in the case of the DG investor, rising dividends and cash flow within the portfolio. The "protect your capital" and "protect your income stream" ideas don't seem to be so prominent until one passes through the accumulation phase and into the living-on-distributions phase.
While it is true that a wage earner will not suffer a cash flow crisis as long as the next pay check is coming along, the distinction between accumulation phase and distribution phase from the standpoint of capital preservation is arbitrary. Protecting capital earlier in one's investing history actually has an outsized effect on one's security in the long run, as one is likely to be more vulnerable to discrete losses early in one's investment history. First, there's the experience thing. Second, there's the relative lack of diversification as one builds the number of positions over time. Third, there's the opportunity loss of future earnings if one makes a big mistake with assets that could have 30-40 years to compound if carefully protected.
A dividend cut is a capital killer. It is a symptom of an engine that is failing. Earnings are failing, and the company turns it's resources inwards as it attempts to repair the damage. The company may recover its valuation completely over time but that dividend is your electric bill if you're in the distribution phase.
The investor is faced with a set of challenges; should you do nothing? should you wait and then respond to dividend cuts? Should you anticipate them and attempt to abandon/switch ownership before such an event happens? Avoiding capital losses seems to mandate the anticipate/avoid strategy.
Dividend cuts are always proceeded by something. The company management and board make a decision based on their view of the near term future. They see a threat to earnings, or they have already realized the damage and are now attempting to repair it. They need cash for something other than the dividend. The question is, can you (the owner) anticipate these events and choose to change ownership before the ship hits rough water?
What do you have at your disposal?; You can wait for the announcement of a dividend cut. Problem is, valuation has already taken a big hit by then.
You can look for signs of impending trouble. What might these be?
Deceleration of earnings growth
Deceleration of dividend growth
Rising payout ratio
Rising debt
rising ratio of debt to free cash flow, enterprise value or other similar ratios
Oh boy... that means monitoring. How many data points? How often? what to do with warnings? watch list? sell? what to do with the cash?
Can you innoculate the portfolio against the kind of companies that could face a dividend cut?
credit rating? Payout ratio? Cap on dividend yield?
eyes closing, rounds and surgery on New Year's Day, must pack it in.
resolutely resolving
The clock just turned into the new year. One minute to the next. What is significant about that? Why do we celebrate one minute, one day? Isn't it all a continuum? If one needs to mark a waypoint, then why not mark it with a significant resolution? New Years Resolutions...made to be broken, right?
what makes that rare beast, the resolution one keeps? I wish I knew.
What about my retirement investing life? What could happen in the new year? In the last year I saw a 10+% growth in value, not counting new contributions. I suppose the market could take it all back, even more. What would that do to my resolve? Am I convinced enough to stay the course? I know one thing; higher or lower valued, the portfolio will spin off 35k plus another 5-7% in dividends, so perhaps 37k. I'll add another 55k in contributions, for 92k. That could mitigate nearly 10% against a down-draft. If the valuation stays even, the dividend plus new contributions will grow the corpus by nearly 10%. If valuations rise, the corpus could rise further than 10%.
We have a richly valued stock market, margin compressions in many industries for this reason and that, prospects for rising interest rates that tend to depress the value of multiple types of investment. I guess I shouldn't keep my hopes up for the most optimistic scenario in valuation.
So, will I stay the course? I can't see an alternative. Am I disciplined enough to critically monitor my holdings? Funny; some of the best minds I know say buy, hold forever. That takes some of the pressure out of monitoring. That means that the most important question is, did I make prudent purchases? As I scan my portfolios, it seems like I did. I culled out the bad ones. There's a reason for every position I hold.
So, I resolve to stay the course. I resolve to only sell when something goes fundamentally wrong with a business. I resolve to only buy stocks that I will hold even if they lose 25% or more of their value in the short term. I resolve to focus on rising dividends, reinvestment, watching share counts grow, income grow, watching earnings, margins, payout ratios and trying not to look so often at the valuations. I resolve to believe that the US economy is the most resilient one in the world, the safest store of wealth, the one with the brightest long term prospects over time. I resolve to keep reading, constantly. I resolve to engage in conversation with peers. I resolve to be respectful and constructive in my comments. I resolve to keep an eye on the goal with each purchase, each balancing move. I resolve to only buy more stock if the valuation is acceptable, not just because cash is burning a hole in my pocket.
tall order, but since I have been practicing all this, there's a reasonable chance I will pull it off.
Happy New Year.
what makes that rare beast, the resolution one keeps? I wish I knew.
What about my retirement investing life? What could happen in the new year? In the last year I saw a 10+% growth in value, not counting new contributions. I suppose the market could take it all back, even more. What would that do to my resolve? Am I convinced enough to stay the course? I know one thing; higher or lower valued, the portfolio will spin off 35k plus another 5-7% in dividends, so perhaps 37k. I'll add another 55k in contributions, for 92k. That could mitigate nearly 10% against a down-draft. If the valuation stays even, the dividend plus new contributions will grow the corpus by nearly 10%. If valuations rise, the corpus could rise further than 10%.
We have a richly valued stock market, margin compressions in many industries for this reason and that, prospects for rising interest rates that tend to depress the value of multiple types of investment. I guess I shouldn't keep my hopes up for the most optimistic scenario in valuation.
So, will I stay the course? I can't see an alternative. Am I disciplined enough to critically monitor my holdings? Funny; some of the best minds I know say buy, hold forever. That takes some of the pressure out of monitoring. That means that the most important question is, did I make prudent purchases? As I scan my portfolios, it seems like I did. I culled out the bad ones. There's a reason for every position I hold.
So, I resolve to stay the course. I resolve to only sell when something goes fundamentally wrong with a business. I resolve to only buy stocks that I will hold even if they lose 25% or more of their value in the short term. I resolve to focus on rising dividends, reinvestment, watching share counts grow, income grow, watching earnings, margins, payout ratios and trying not to look so often at the valuations. I resolve to believe that the US economy is the most resilient one in the world, the safest store of wealth, the one with the brightest long term prospects over time. I resolve to keep reading, constantly. I resolve to engage in conversation with peers. I resolve to be respectful and constructive in my comments. I resolve to keep an eye on the goal with each purchase, each balancing move. I resolve to only buy more stock if the valuation is acceptable, not just because cash is burning a hole in my pocket.
tall order, but since I have been practicing all this, there's a reasonable chance I will pull it off.
Happy New Year.
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