I am 37-years old believer. Yes, I believe in Dividend-Growth investing for total returns. But truth be told, I started out as a capital-gains investor who couldn't spell dividends. My faith in dividend yield and dividend growth increased slowly but surely over the last three years.
The Early Investor
I started investing a few years ago and self-educated myself via personal finance magazines, The Wall Street Journal, investing websites and various online forums. I considered (still consider) myself to be a value investor and would buy into obscure companies based on stories. I was looking for true growth stories that would be multi-baggers but be different from most by trying to avoid "the flavor of the month." I constantly looked for stories like emerging market explosion, diamond in the rough, hidden value, unduly punished etc. However, as it turned out
- I often bought value traps - companies that appear as great value but where there is a real reason for the low prices. Inherent issues with their business models or the market they serve or management issues etc.
- I cannot evaluate balance sheets and find a rational price to buy/sell using PEG, Discounted Cash Flow, etc. I understand the mechanics and the arguments behind most but it is a different story to find a multi-bagger.
- I would often be late to the party, buying a stock after a decent run up
- I don't realize when the party is over and when others have sold and moved on.
- I had trouble finding stock(s) where I felt comfortable investing savings every month.
The Transformation Begins
I had my Aha! moment listening to a colleague at work who invested in a hot IPO and made a cool couple of thousand dollars in a week or so. He then spent it all and then some on a Caribbean cruise. I realized that is not who I am. I am not a gambler/speculator looking to make a few thousand dollars here and there. I am not looking to buy a stock once every few months based on intuition or tips and then go blow away lucky profits. Rather, I see the market as a wealth creation opportunity. I want to invest our monthly savings and build our net worth for l retirement and kids' education.
The next Aha! moment a few weeks later was when I saw that I was doing better with my dividend aristocrats (and champions) that I had picked up on bad market days. That I had no special skills or temperament to find the next Google (GOOG), Apple (AAPL) or Netflix (NFLX) before they become big. Instead, I can use historical financial performance and investing disclipine to achieve goals that I set out for myself. This realization came with introspection into which of my picks did well and (perhaps) why? Which stocks give me less frustration and more happiness year after year?
As I went along analyzing my portfolio, I slowly figured who I am and what I expect from stock investing. I set out some rough principles and goals for myself. I use them as a guide and will not cast them in stone. They may be a bit vague but they provide encouragement in times of despair and keep me in check during times of irrational exhuberance.
- Approx 8% total returns year-on-year. I imagine I may range anywhere from -25% to 50% in a year but over a decade, I aim for 8%. I don't need the 5% every week that I hear people earning.
- Incorporate dividend stocks to help achieve the above goal. Stocks with a dividend yield of 2%-6% are often in the sweet spot of manageable payout ratio and debt ratio with reasonable betas (low volatility). I would feel comfortable adding funds to such stocks month after month.
- But the stock market is all about future growth. About companies creating value and wealth using raw materials and human capital. My proxy for value + growth is dividend growth stocks. Sustained dividend growth would imply a larger dividend yield every year. But there are hungry dividend yield vultures out there. They will swoop in every time yield becomes high and that would drive the stock price up.
- Don't penalize a company that freezes dividend hikes or even cuts dividends due to severe market conditions.
- Use limit orders and buy dividend growth stocks on days when the market thinks that the sky is falling.
I am on track of building a strong portfolio where I feel comfortable investing all our savings. Of course, only after keeping aside nine months of living expenses in a money market account. But other than that, I don't feel the need for Bonds or similar instruments.
Dividends are harder to fake than other accounting numbers since they represent actual cash flow. Granted nothing is sure and secure (otherwise there wouldn't be a vibrant market) but companies that pay regular dividends and have been increasing them for years are likely to be around a few years and need less monitoring than pure growth oriented stocks.
My simplistic model is that if a company increases the dividend by x-% and if there is no P/E compaction then the price would also increase by x-% to keep the yield the same. Obviously, the linear equation does not reflect real life but comes reasonably close. Additionally, I target lower P/E based on the historical norm at the time of entry. This contains the risk and further enhances scope for total returns (stock price appreciation).
Here are some of the "mistakes" that I made. Stories that never unfolded. Stock prices that never went anywhere. Dividends that never came (or increased) while I patiently waited for capital appreciation:
Air Transport (AIRT), Astec Industries (ASTE), Bolt Technology (BOLT), General Cable (BGC), Bruker Corp (BRKR), Dynamic Materials (BOOM), Foster Wheeler (FWLT), Graham (GHM), Himax (HIMX), Hurco Manufacturing (HURC), KTron International (KTII), Nvidia (NVDA), Powell Industries (POWL), Turkcell (TKC), Village Super Market (VLGEA)
There were many more. But then along the way, I picked up some of the following by accident or design. Their continued dividend increases, low stock volatility, consistent financial results and good corporate governance continues to impress me. I try to make additional purchases whenever possible.
Emerson Electric (EMR), Dover (DOV), Lincoln Electric (LECO), Nacco Industries (NC), Darden (DRI), Procter & Gamble (PG), BASF (BASFY.PK), BHP Billiton (BBL), Cooper Industries (CBE), Crane (CR), Lockheed Martin (LMT), Novartis (NVS), Sun Hydraulics (SNHY), Intel (INTC)
I would be happy to discuss any of these or other stocks in the comments section if anyone is interested.
Each investor is different and we need to realize this. We don't need to emulate others - perhaps just learn from them. Coming up with my goals and sticking to basic principles has helped me build a strong portfolio that I am comfortable with.