Emotionless Dividend Investing

Investors often fall in love with stocks, which are synonymous with innovation, growth and have delivered strong total returns up to a point. It is easy to fall in love with a stock, which everyone else is touting as the next great thing, whose products you use or is one which has made many investors rich.

The main problem with such attitude however is that it could cause investors to throw their carefully researched strategies out of the window and engage in careless speculating. This could cause severe losses of capital over time.
Investors have suffered two major blows over the past decade – the tech stock crash in 2000-2002 and the financial meltdown in 2007-2008. The first occasion was a complete euphoria for anything related to technology or dot coms. College dropouts were selling stock in their money losing eyeballs attracting online ventures in IPOs, which were valued at billions by Mr. Market. Needless to say the tech boom turned into a bust that left millions of investors suffering tremendous losses. Even investors in great companies such as Microsoft (MSFT) and Intel (INTC), which were enjoying double digit revenues and earnings growth even after the meltdown, suffered huge losses because they overpaid for future growth.

The financial meltdown was characterized by investors who were holding on to safe income investments such as Bank of America (BAC), Citigroup (C) and General Electric (GE), which had a long history of consecutive dividend increases. As these stocks began their slide, they cut their distributions and had to take billions in aid from the federal government. Investors who kept a cool head and didn’t chase high yielding stocks blindly, right before they cut their dividends would have saved a lot of precious capital to be used for later.

The point being taken is that entry price paid for stocks does matter. If you mindlessly reinvest dividends or dollar cost average your way into an index fund you would end up paying top dollar for the inflated future income stream from these investments. Thus, having strict entry criteria might prevent you from chasing hot stocks and losing a lot in the process. This entry criteria could also prevent you from investing in companies, simply because you like their brand or your hope that their business would turn up for the better. Even great brands such as Johnson & Johnson (JNJ) or Procter & Gamble (PG) were not good buys when they traded at more than 20 times earnings and yielded only 1% in the early 2000s. There were other companies, which yielded much more than that and traded at lower price to earnings multiples that should have been on investors’ radars. It is better to sit in cash than overpay for stocks and then have to wait for a decade before you start generating any meaningful return on your investments.

One also needs to have a sell policy, which lets you out of a losing position no matter what. When one buys a stock because it pays a stable dividend, it does not make sense for them to hold onto the stock if the company eliminates its streak of 30 consecutive distribution increases while citing the weak economy. When you take the loss, you would start thinking more clearly. If you hope that it would turn better, you would lose money in the process. When Citigroup (C) cut its dividends for the first time on January 15, 2008 the stock closed at $26.94. Investors who sold at the time would have saved themselves from huge losses in the process.

At the end of the day, only the disciplined dividend growth investor who is careful not to overpay for stocks, and has the discipline to sell when some of his criteria are no longer intact, would be able to generate a sufficient income stream for their future needs.

Disclosure: Long JNJ and PG

Comments

[mbkelly75:]

Falling love with a stock or any other investment can be a real problem. I agree with you wholeheartedly on this point. Dollar Cost Averageing in a way that raises your cost-basis is not a good thing either. HOWEVER, dividend re-investing is NOT the same thing as a dollor cost average program. Dividend re-investing (especially when done commission-free as my broker does for me) always lowers the cost-basis - it NEVER raises it.

I always sell a stock when it cuts it's dividend. The drop in price that usually results from a cut in dividend can make a great investment re-entry point - cutting your cost-basis and giving you more shares than you had before for the same dollar investment amount - if it is a solid company like GE who had good business reasons for cutting the dividend - it was not simply a last, desperate move from a dying company.

Oct 07 11:47 AM

[stink726:]

mbkelly75 - Why can't dividend reinvesting ever raise your cost basis? As an example, if I buy 100 shares of a $25 stock which then rises to $30 before the first dividend is reinvested, those new shares will have a $30 basis bringing the entire group slightly higher, won't they? Or am I missing something?


On Oct 07 11:47 AM mbkelly75 wrote:

> Dividend re-investing (especially when done
> commission-free as my broker does for me) always lowers the cost-basis
> - it NEVER raises it.
>

Oct 07 02:45 PM

[mbkelly75:]

You are missing something. The dividend is actually cash back from the company - your share of the company's earnings. If you re-invest those earnings - from what is essentially free cash - it reduces your cost per share as you have more stock without any more cash investment on your part. This is why places like CAPS reduce your cost per share by the dividend whenever you get one. The actual cost of the shares makes no difference at this one time. If you sell the shares you bought to get the dividend, after they move back up in price (they usually drop when the stock goes XDiv but recover in a few days) - then you will have shares of stock with no cash of your own in it - zero cost-basis - provided that you get enough shares to start with that the amount of the dividend is more than your commission costs. For me - that is $8 total so that is not really too hard to do. Think about it.

Oct 07 03:59 PM

[notsosmart:]

i bought GE @ $7.61. the yield @ that price is great providing the y dont cut the div. again. my average for this stock is now $18.00 but i collected the original div. for many years. i also own a tanker stock paid for completely by the div. the yield now (in bad times) is still over 4%.the key to all this is the entry price & the quality of the co.the drip plans of good cos. made my retirement little or no fees of these plans,plus you can buy shares directly,are a great way to invest in this ponzi/casino that wall st has become.you need time & patience & its boring but it pays.

Oct 07 06:00 PM

[stink726:]

mbkelly75 - Thanks for the info.

Oct 08 01:26 PM

[mbkelly75:]

You are welcome. Cost-Basis is SO important that I keep a written record of that and several other details of all of the securities in both of my portfolios - updated monthly at the very least.

Oct 09 06:14 PM

[Tom S.:]

mbkelly75, if you're purchasing stock with money that you could've spent (your dividend), why do you say that it's costing you nothing? It's actually costing you cash that you're removing from your bank account, right? And, for tax purposes, you add all reinvested dividends to your initial investment to get your cost basis (cost per share). So you are actually altering your cost per share each time you reinvest a dividend, but it can go up or down, depending on the stock price at the time of the reinvestment.

Oct 12 03:51 PM