The Dilemma For Fully Invested Dividend Growth Investor
Here's an interesting passage from a recent article by Seeking Alpha Author Gary Gordon:
According to a Wealth-X census, the world's billionaires have roughly 22.2% of their total net worth in cash. That's the highest percentage since tracking began in 2010. Why are the wealthiest among us choosing an asset that currently yields next-to-nothing?
Is the defensiveness warranted? Recent volatility alone suggests that it might.
From here, the share market could go up, down or sideways
Nobody knows whether the share market will go up, down or sideways. And that poses a dilemma for fully invested DGI investors. Back in 2008 to 2009 there was a lot of residual fear in the market following the GFC events. No one really knew whether the share market would go up, down or sideways. In fact, the share market has risen since then at an increasing pace as fear has faded. Those who stayed in the market have done very well compared to those who stayed in cash. In 2016, I would say there is again considerable fear in the share market. But, it is offset by the fear of unnecessary loss of income if DGI type investments were converted to cash and there was no market downturn in the short to medium term. Even at currently elevated share prices, there is no greater certainty whether the share market will go up, down or sideways from here.
The return of volatility
If a DGI investor does elect to convert part of their holdings to cash in anticipation of the possibility of an enduring downturn in share market valuations, they will need a strategy for buying back in, if and when share prices do fall. Currently, volatility has largely disappeared, likely due to the Fed's intervention. I believe if the share market does start to turn down from here, it will be accompanied by a return of increased volatility. This could give rise to a means for profitable employment of those cash holdings.
Buying the dips and selling the rises
One of the problems I perceive with attempting to buy the dips and selling the rises is the uncertainty whether the dip is just a hollow in the hills, or the rise is a hill in a hollow. It is also impossible to know in advance when the dip has reached its lower limits and when the rise has reached its upper limits. Before going into the detail of the proposals for dealing with these uncertainties, I have to emphasize these scientific methods and formulae are only intended for shares with a long proven ability to bounce back from setbacks and to achieve increases in share price over the long term. That necessarily limits the selection to carefully chosen Dividend Aristocrats and other enduring and top performing companies. I have previously reviewed the application of the rules and formulas utilizing historical share price and dividend data for Johnson & Johnson (NYSE:JNJ) (see here). The historical pattern of dips in share price differs between Johnson & Johnson and Coca Cola. This review looks at the results of applying the rules and formulas to Coca-Cola (NYSE:KO) historical share price and dividend data.
The Rules And Formulas
The rules and formulas for buying dips in the share price and subsequent sales of shares at higher prices are set out in TABLE 1 below.
A range of past price points is used to provide necessary checks and balances to indicate the current fall in share price is an actionable dip in share price level. In addition, a range of share price dips starting at 4.5% to 8.99%, and increasing in increments of 4.5 percentage points through to 31.5% and over, are used to reserve cash for ongoing dips in share price subsequent to an initial price dip. Sales of shares are made once the share price reaches at least 10% above the highest share price for the latest batch of shares purchased in the most recent series of dips. This is meant to ensure profits on sale are achieved, while at the same time returning cash levels to the initial amount, in readiness for use as further dips in share price occur.
Allocation of cash
In my previous article, as repeated in TABLE 1 above, the allocation of cash to each increment was weighted towards the front end of the Buy Signal Ranges (BSRs 1 & 2 - 50% of cash allocation) to limit excessive idle cash in periods of low share price volatility. The balance 50% of cash was held back to take advantage of the progressively larger price dips for BSRs 3 to 7. TABLE 1 above shows the number of opportunities to buy KO share price dips at the various BSR price levels. I have also included for comparison the number of opportunities there were to buy JNJ share price dips at the various BSR price levels. It can be seen for KO, there were only five (5) opportunities to buy at the BSR1 level compared to ten (10) for JNJ in the 16 years 2000 to 2016. While the number of opportunities to buy the dips were less for KO, the share price falls were generally greater in percentage terms than for JNJ. And of course, the potential gain per share bought and sold was greater at the BSR3 to 5 levels where opportunities to buy the KO dips exceeded the opportunities for JNJ. The question arises, should we hold back a greater portion of our cash reserve of $100,000 to take full advantage of the higher share price gains at the BSR levels 3 and above? The only way to answer this was to run a series of models allocating the whole of the available cash at each BSR level. So for BSR1 the whole of the available cash would be used 5 times over, as there were 5 occurrences that triggered a buy. For BSR2 to 4, the whole of the available cash would be used 4 times over, as there were 4 occurrences that triggered a buy at that level or above, and so on. The results of this modeling are summarized in TABLE 2 below.\
From TABLE 2 above it can be seen that committing all the cash at the BSR4 level was the winner. In fact, for all options for deploying cash, bar BSR6 & 7, the shares and cash option bettered the all shares option. This is different than for JNJ where the high number of BSR1 opportunities made it the best option, and the only option to better the all share option. For KO, investing 100% of cash at the BSR1 level still gave a better result than a shares only strategy. It is worth analyzing the results a little further into the period 2000 to 2010 and the period 2010 to 2016, as per TABLE 3 and TABLE 4 below.
The 2000 to 2010 period was one of considerable volatility for the KO share price and for the share market in general. All of the BSR2 to 7 occurrences took place in this ten year period, and none since. The cash for the Buy the Dips strategy is designed to take advantage of share price volatility. It is not surprising that results for all BSR1 to 7 surpassed the shares only strategy in this 10 year period. Once again, allocating 100% of the available cash once the BSR1 level was reached or passed would have been a simple and effective approach.
To obtain a fair comparison of performance of the BUY the Dips strategy in this period we needed to start again with the $500,000 for shares only and $100,000 cash plus $400,000 shares for the Buy the Dips strategy. As there were no BSR2 to 7 occurrences in this 6 year period, the $100,000 cash sat idle and did not contribute to growth. There was only one BSR1 occurrence in this period (a share price dip greater than 4.5% and less than 8.99% below the previous year's average daily share price). This compares to JNJ which had 4 BSR1 occurrences in the same 6 year period.
Summary and Conclusions
Compared to Johnson & Johnson, there were fewer actionable dips in the Coca Cola share price over the 16 years 2000 to 2016. But when share price dips did occur they were mostly deeper and more savage for Coca Cola than for Johnson & Johnson. Over the 16 years, the optimal result for KO would have been achieved by holding back cash until BSR4 level was reached. The result for simply investing 100% of cash at the BSR1 level was not too far behind. It would also have been the better option over the last 6 years where there has been low share price volatility for KO. If similar volatility to the 2000 to 2010 years should return, the BSR1 strategy with 20% cash element, might well provide improved returns over an investment wholly in KO shares. I still believe there is potential for even greater profit from Buying the Dips and I will put my mind to that for a further article.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such
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.