A good question for most long-term investors to consider is whether or not they can handle seeing the stock price of their holdings fluctuate by 50% or more. This is important to keep in mind because even stodgy blue chip companies like Coca-Cola (KO), Procter & Gamble (PG), PepsiCo (PEP), Johnson & Johnson (JNJ), Colgate-Palmolive (CL), and Chevron (CVX) have experienced steep declines in price this decade. I've included a chart of each of these companies to document the difference between a high price point and a low price point.
For example, someone who bought shares of Procter & Gamble for $59.20 in 2000 saw the price per share fall to $26.40 that very same year. If someone had bought $200,000 worth of P&G stock, they would have seen the market value fall to $89,189. Ouch. It's certainly easy to think "that type of decline won't happen to me." After all, the valuations of many blue-chip companies became preposterously high during the dotcom bubble (although not as high as many tech stocks). For example, Johnson & Johnson traded at $61 per share in 2001 relative to $1.91 in earnings per share. That's a 3.13% earnings yield, and the company offered a 1.1% dividend yield at the time.
To the extent that earnings yield factors into my potential investment calculations with mega-cap blue chips, I aim for at least a 10% earnings yield, and a dividend yield in the 3-4% "sweet spot" range. By these metrics, Johnson & Johnson was about three times as expensive as what I would ordinarily like to pay when establishing such an investment. My primary objective as an investor is to buy the greatest amount of risk-adjusted profits at the lowest price I can find. In the case of Johnson & Johnson in 2001, paying triple my comfort zone for an investment does not sound like a formula for success. So I can understand why some investors might believe that they are immune to such steep declines since they would make investments with a much greater margin of safety than was available during the highs of the examples that I used. That's fair enough.
I misspell Procter & Gamble often enough to get messages from irate P&G shareholders who have owned the company for decades and have grown tired of dealing with people who spell Procter with an "O". Sometimes, I engage these folks in further conversation, and they tell me about the joy of watching Procter & Gamble compound by double digits over the decades. Well, I want to eventually be one of those people who hold onto a fantastic business for decades on end and watch the earnings and dividends compound into something great. In order to attempt this feat, I need to approach the realities of long-term investing with a clear-eyed view that acknowledges the potential pitfalls along the way.
But still, someone who bought Procter & Gamble stock in 1995 and plans on bragging about it in 2020 will have experienced the reality of seeing the share price fall from $59.20 to $26.40 in 2000 and from $75.20 per share in 2007 to $54.90 in 2009. The way I see it, these fluctuations are the "price of admission" that comes with investing in dividend-growth companies for the long-term. During the accumulation stage of my investing life (say, the next thirty five years or so), I plan on embracing such declines in high-quality blue-chips, since it grants me the opportunity to follow my objective to buy a greater amount of profits at lower prices. But this process can get scarier once the amount of money involved represents a decent-sized chunk of life savings that is greater than the amount of money I could conceivably make in a year or two. When you're trying to build something great, experiencing a decade's worth of money saved disappear during a steep stock market decline could potentially be one of those moments that tries mens' souls.
The marathon that is dividend-growth investing does not come without its hurdles. During the initial stages of dividend investing, an investor must cope with the potentially un-motivating experience of seeing $5-$10 dividend checks arrive. By the time the investor reaches the other end of the spectrum and is receiving $1000 dividend checks, he will most likely have to cope with fluctuations in the tens or hundreds of thousands of dollars, which could be a disastrous experience if the investor is not mentally equipped to watch the market value of his investments decline from $500,000 to $325,000. I think that dividend growth investing via excellent companies that offer 7-11% annual earnings and dividend growth is the surest way for me to go, and I plan on following this strategy with eyes wide open, so that I can keep my cool when those 50% declines knock at my door.