How A Big Loss Made Me A Dividend Growth Investor

Includes: MCD, XOM
by: Larry Smith

Thomas Edison once said, "I haven't failed, I've found 10,000 ways that don't work." That quote summarizes how it is I became a dividend growth investor. Everything I tried failed, until I discovered dividend growth investing. I did not fail 10,000 times, but I did have one large failure that pushed me to dividend growth investing. That failure was an investment I made in WorldCom back in 1998.

That period was the height of the internet bubble, almost every day some internet company came public and rocketed up, sometimes doubling in price on the first day of trading. Financial magazines, newspapers, television shows were all proclaiming a new era had arrived; the internet would change how we live. Reading and hearing all this excitement everyday convinced me, I had to get in on this, easy money awaited me. I did research by reading some magazine articles and listened to various talking heads on television. One name that made sense to me was WorldCom; this telecommunication company had the best "backbone" for the roll out of the internet. WorldCom at the time was the second biggest telecommunication company in the United States behind AT&T (NYSE:T) and was the leading carrier of internet traffic. The company did not pay a dividend, but it was growing fast through acquisitions and I thought I would ride the stock to riches. I bought two blocks of shares for an average price of $45.50 and confidently waited for the shares to appreciate. That confidence would soon disappear.

In early 2000, the stock market started to decline, as did WorldCom's stock price. Added to the overall declining market, WorldCom had tried to merge with Sprint (NYSE:S), but the deal was blocked by the government, which the market also did not like. Then the news broke that the CEO was getting margin calls on his large block of WorldCom stock that he had margined to make investment in his other ventures. That news sent the stock spiraling lower. Shortly after that, an audit committee found full scale accounting fraud and the rout was on as everyone ran for the exit. I sold ($16.00) before the final plunge occurred, but I still took a 63% loss.

That loss was a changing moment; I had never lost that much money and I did not like it. I had only myself to blame and so I decided to review my investing process to see if I could determine what I did wrong. It was during this review that I realized I was an aimless investor, no real strategy, just buying whatever stock appealed to me. Some small, some big, some just because I thought the company was cool. I had some gains and had some losses, but I was not really getting anywhere. I then vowed to change how I invested.

I knew I wanted to minimize my chance of having a big loss; I also wanted to be paid while I held a stock and I wanted to buy stocks when they were on sale. I decided the best path for this was to buy large well - known companies that paid dividends and hold them. I did not call this dividend growth investing, or give it any other label, it was just my plan. I knew and accepted that none of these companies would skyrocket overnight, but I also knew that they would not plunge to zero. I also knew, that the dividends re-invested, would over time, add to my gains. I vowed to hold these stocks as long as their basic story remained intact. Most important of all, I told myself I had to patient and let time work for me.

Since changing my investing approach, a number of positive things have happened.

  1. I sleep better at night, I do not worry about the financial health of any of the companies I own. They all have solid balance sheets and have been paying dividends for a long time. The first rule of investing is my most important rule. Do not lose money.
  2. I have seen first-hand, the value of dividends and now would never buy a stock that did not pay one. I first bought McDonald's (NYSE:MCD) in January of 2008 for $50.23; I have added shares at various times since then and now have a cost basis of $53.79. On stock price alone I have a gain of 80.85%. However, if you add in the dividends I have been paid, I have a gain of 96.98%. In just four years, the dividends paid have given me an additional 16% return. Over time that will continue to rise.
  3. My returns have greatly improved, although I have had some losers, those losses have been small, all under 10%. I have had more patience with winners, allowing them to continue growing and letting the dividends pile up. My benchmark for success is beating the returns on the S&P 500 (NYSEARCA:SPY) and most years I have done that. The years I have not, like 2009, were years the S&P posted big gains and my portfolio of conservative slower-growing stocks did not rise as much. However, years like 2008 where the S&P lost 37% and I eked out a 1% gain more than make up for it.
  4. My yearly dividend stream continues to increase. For now, I reinvest the dividends quarterly, after all the dividends have been paid, in whatever stock in my portfolio I believe is the best bargain at the time. However, I know at some point in my life, I will be enjoying the dividends as additional income.
  5. Probably the biggest change is my mindset as an investor. I do not worry about the day-to-day action of the market and look forward to market pullbacks, happy to purchase shares on sale. I have become more patient as small price declines in my shares do not faze me. An example of this would be my accumulation of Exxon Mobil (NYSE:XOM) shares. I have owned shares in Exxon for almost four years, initially buying shares in October, 2008, for $67.66. Since then, I have added shares at various prices, including as low as $56.53 in July of 2010, resulting in a current cost basis of $65.55. More shares, lower cost basis, bigger dividend is a formula for success.

I understand that there is more than one way to successfully invest; other investors have found success through commodities, options, growth stocks and other styles of investing. However, for me, the benefits of dividend growth investing, both financially as well as mentally, provide the best approach.

Disclosure: I am long MCD, XOM.