The DJIA finished the first week of 2016 down more than 1,000 points, its worst first week ever. The big question on investors' minds is whether the market will snap back next week, as we've all been conditioned to believe since corrections of late tend to be intense and of short duration, or are we going to keep going down and how fast?
Sorry to disappoint those looking for the answer, but I really have no idea. Does that mean I don't know what I'm going to do? Absolutely not. I've been investing (I don't trade) for over 30 years and I know exactly what I'm going to do. I am going to follow my long-term plan as I've disciplined myself to do, which includes buying good dividend paying, profit/dividend growing companies with reasonable payout ratios and strong balance sheets that are in the top few in their industries. Also, I have always had an investment time horizon that I measure in decades.
I try not to "time" the market, but that doesn't mean I'm oblivious to when I buy. One of the main factors for my purchase decisions is yield on cost (YOC). That is defined as the annual current dividend divided by the original purchase cost. Therefore, I look at annual dividends, analyze their prior growth rates as well as projected future profit growth and assume dividend growth will mirror profit growth over the long term. This assumes that there is no increase in the dividend payout ratio, which I find to be a conservative assumption. If a company decides to increase its payout ratio (i.e. it is going to increase its dividend growth rate faster than its profit growth rate, I consider that "gravy"). However, if it decides to reduce its dividend growth rate vs. its profit growth rate, that is a warning signal for me. The key is what they intend to do with the profit growth that they are not distributing to shareholders in the same payout ratio as in the past? If it is to increase reinvestment in its company for a reason that I find valuable (a potential acquisition, movement into a more profitable area of its businesses, etc.), then I view it as if the decision is a deferral of dividend growth so that they will be able to provide larger profit growth in the future and, therefore, larger dividend growth as well.
Remember that the only way for you to profit from a continuing investment in a company is through dividends. You can certainly profit via capital gains, but that isn't a continuing investment. That is from a reduced investment. (I do not include trading profits as I am a long-term investor and not a trader).
All this being said, I do want to maximize my YOC. That means that if the price after I buy continues to go down, I have purchased at a YOC lower than I could have if I waited. Expecting to always purchase at the optimal YOC is a fool's errand.
So at times like this past week, what do you do? First, you read as much as you can, and Seeking Alpha provides you an enormous wealth of really smart, experienced investors. You determine who your "Go To" experts are in various areas and "Follow Them" on Seeking Alpha (just click on the button "Follow") so you always know what they're saying. If there is a stock you're interested in (after doing your own research regarding some of the areas I've mentioned such as profit growth, dividend growth, market growth in their industries, future potential, longevity of the company, etc.), figure out what your minimum YOC is at which you'd purchase it (take the annual dividend and divide it by the annual dividend rate you want to earn and that will tell you the price at which you would need to purchase it). As an example, if a stock pays an annual dividend of $1.00 and you want to earn at least a 4% dividend rate, then you must buy it at a price of $25 or less in order to earn that rate. If the stock is currently selling for $25.75, at the beginning of the next trading day, you can put in a limit order for a price below $25 (remember to include your transaction costs as part of the equation as you need to reduce your limit price to cover those costs in order to earn the rate you want).
Getting back to the question of whether it's time to panic? That's an easy answer for me. There's NEVER a good time to panic. What helps to prevent panic? HAVING A PLAN. If you have a plan to follow, that should be your focus. Is it as easy as I say? Heck no! We are all human beings and emotions are part of our make up. Discipline and patience are the two traits that we have that can help subdue panic. It won't eliminate it in many people (including me), but the question is whether you let the panic bubble to the surface and cause you to act or whether your discipline, patience and plan can overwhelm your "panic desires?". THAT is what you need to accomplish.
Actually, in order to be a successful investor, you need to be able to actually invest when your panic is telling you to sell and get out. Again, you need to remember that you are a long-term investor and you have a long-term time horizon, which means if you don't have at least 5-10 years before you may possibly need this money, it shouldn't be in the stock market to begin with.
The best example I can give you comes from my own experience back in October 1987. If you would have invested money in the market on August 25, 1987, the day the DJIA reached its year's high, you would have seen the market go down about 12% from then until Friday, October 16th. On Monday, October 19, 1987, the market crashed 22% just that day (the markets now have circuit-breakers to prevent this from happening). That means from the day you invested in the market, you could have seen a 34% unrealized loss in your portfolio (if it mirrored the DJIA - they didn't have ETFs back then). You could have all the discipline and patience imaginable, but panic was almost impossible to suppress. It might be easier to deal with now, mainly because of the experience of going through it then. What would make it easier now? Knowing that when the market closed on October 19, 1987, the DJIA closed at 1,738.74 (by the way, this was also after oil was dropping 50% and issues in the Middle East - sound familiar?).
The question I pose to you is, as a long-term investor, who now would raise their hand to invest their money on August 25, 1987? If you consider your hand raised, how would you have felt at 4 PM on Monday, October 19, 1987? This is the best example I can give about panic, discipline, patience, and having a plan to follow.
Do you buy on Monday morning? If you do, I would recommend just dipping your toe in the water for what you want to buy. I also find that if you own a stock in your portfolio, you tend to follow it more extensively than if you don't. Pick up 50 or 100 shares if it meets your limit price for a YOC you are happy with. If the stock goes down further, pick up some more when it drops another 5% (assuming it does) as long as your long-term thesis for the stock/company hasn't changed.
What you need to look for as a signal that the correction may be over is what is termed a "washout." This is when all those panicking and the high-speed computer trading models all head for the door at about the same time. Move out of their way. Is a 1,000 point drop in the DJIA a washout? I don't think so, but that is just my opinion. Remember that on August 24, 2015, we had a 1,000 point drop in the DJIA in about an hour. THAT is a washout.
I have no idea what or when the washout will be this time, but it is usually pretty dramatic. My point is that if you have a long-term plan to purchase solid, mega cap, dividend paying and profit growing stocks, it won't matter over time. I want the income now, I want the income growing over time, and I have no idea when, if ever, I am going to sell the stock so does it really matter where the stock price is on Monday, a month from Monday or a year from Monday? As long as it pays me the minimum YOC that I'm willing to accept, I can live with it... whether it's August 25, 1987 or today.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.