Dealing With Panic In Dividend Growth Investing

Includes: ITW, JNJ, KO, PG
by: Eddie Herring

The Scenario

Let's imagine for a moment, if you will, you've reached the conclusion the government may not be able to provide a suitable retirement for your purposes. In addition to the urge to "vote them all out," you decide you need to take responsibility for your future retirement into your own hands. You've been able to save a few thousand dollars, so you open up an online brokerage account to use for retirement. You've been hearing quite a bit about how popular dividend growth investing is. All you need to do is just hold the stocks and grow the ever increasing income. Given enough time, you'll create enough income to provide a decent retirement.

You don't have a lot of extra time to manage your account, so you decide to use that approach. After some basic research, you decide to buy Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), Illinois Tool Works (NYSE:ITW), and Coca-Cola (NYSE:KO), all solid dividend paying companies. It's July of 2011, summer vacation time, and for a couple of weeks you're away from monitoring your account. You return to find that your total account value is down significantly, a lot more in terms of dollars than you ever expected it could possibly be. You begin to panic. You wonder if you should sell and start over, or if you made a mistake thinking you could do this yourself. What should you do?

Although I'm writing this primarily for newer dividend growth investors, all of us have, at some point in our investing careers, had those positions that went against us. Not everyone has nerves of steel, and emotions can often get the better of us, driving us to panic and make poor decisions. I'll readily admit I've sold and regretted it. So how should we handle those instances? Here is a suggested way of dealing with this by asking a few questions before taking action. Others may have additional suggestions to add.

The Questions

1 - The first thing to do is to try to remain calm and ask "what is happening here?"

Always try to approach it from a rational rather than an emotional perspective. We enter into a position knowing that a stock moves three ways: up, down, and sideways. When a position is moving against us it is time to analyze the movement to determine if anything has changed. Don't get so focused on the total capital swings of your account that it forces you to overlook the other important aspects of your investing such as growing income each quarter or annually. Remind yourself of your objectives for being a dividend growth investor.

2 - Has anything changed other than the price?

Prior to entering any position, you made a determination as to why you were buying that company. It met your fundamental analysis, it had consistent earnings, was a consistent dividend payer, had a wide moat, etc. Take another look at your analysis to see if you missed anything. Was the dividend cut or frozen? If something has changed fundamentally within the company, then ask if it changes your reasons for owning the company. Does it still meet your investment business plan?

3 - Is it a news-driven event?

Often times, the market will overreact to news events, whether it's an earnings miss, or a reduced earnings target, a government announcement, etc. If it's a news-driven event, does that change the reason for owning the company?

4 - Did I enter at an overvalued price?

Many companies will often trade in a channel or will swing within a certain range. It's quite possible to have entered at a price that you thought was fair value and yet the stock pulls back to a historical range. Don't beat yourself up if you missed the entry.

5 - If I didn't own this stock, would I consider buying it here?

Look at the position as if it was a new entry being considered. If it's at the point where you would buy it if you weren't already in it, should you be selling it or adding to it? It's quite possible that if nothing has changed fundamentally with the company, it may be providing you an opportunity to add to your position and reduce your cost basis.

6 - What is your timeframe for investing?

If this company is one you're planning to hold for years, then you will experience highs and lows. If you entered near a high or overvalued point, which is not uncommon for newer investors, then the fact that the position(s) declined shortly after entry is unfortunate but not a reason to panic or to sell. Review your risk tolerance. All investments have some level of risk and there are no free lunches in the investing arena. If our timeframe is years away, it should help reduce our anxiety to remind ourselves of that.

7 - Is the entire market moving down, is it a sector or industry rotation, or is just the company itself moving down?

Large institutional buyers will often rotate in and out of certain sectors or industries which can impact prices over a short period. Review what's happening with other companies within the industry or sector for the companies you hold that are declining in price. Check the sector or industries ETFs that are available to see how they're trending. Did you make note of the beta before entering? This will give you an idea if the company moves less, in parallel, or more than the market as a whole.

8 - Ask, what are the alternatives?

If you sell you will take a capital loss. Loss of capital is loss of real money. There also may be tax consequences to consider. If you decide to sell, will you be able to replace that holding with some other company, or will you have to wait to build up additional capital with which to invest. Try to weigh the loss on selling against the risk of continuing to hold. It may be that you need to sell, but it should be after you thoroughly evaluate the holding asking the above questions.

It would be easy to say that if one had performed better analysis, diversified more, had better asset allocation (more but smaller positions), etc., then one wouldn't be in this type of predicament. It would also be condescending. We were all at one time inexperienced investors and many of us have learned good judgment through bad experiences. Over time we may also get caught up in much of the minutiae of the market and forget the fundamentals that are essential to successful investing. But we mustn't forget the simple basics such as these questions imply. It always comes back to basics.

In the case of the companies I mentioned above, ITW missed an earnings estimate and dropped significantly. Both KO and JNJ exceeded earnings estimates and PG was between earnings announcements during the period of this decline. While KO held up well, all the others mentioned declined quite a bit. Referencing the S&P ETF (NYSEARCA:SPY) shows there was a general market pullback during that time.

Keep The Main Thing The Main Thing

This article may seem odd in light of the fact that the market has been trending upward for the past couple of years with the exception of the pullback in July of last year. But sometimes we need reminding. Life is easy when the markets or our individual holdings are moving up. Don't let the good times lull you to sleep and not be prepared to deal with the inevitable difficulties that will come. There will be bull markets and bear markets, losses and profits and short-term obstacles to overcome. When our investments are moving against us is when it can really test our resolve. Those of us who were invested or trading in 2007-2008 timeframe certainly had our resolve tested. On the other hand, it presented a wonderful buying opportunity.

The point is that panic is never the answer. That may seem intuitive to some, but emotions often drive decision making. Sometimes we have to grit our teeth and maintain the courage of our convictions. It's necessary to remind ourselves periodically to keep our end objective in mind when making buy, sell, or hold decisions. In his book First Things First, author Stephen R. Covey used a phrase that has stuck with me over the years. It was that "the main thing is to keep the main thing the main thing." If we are to be long-term dividend growth investors, then it's essential to keep our focus on the end target or purpose of our investing, and make decisions accordingly. That's the main thing.

Disclosure: I am long KO, PG. 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.

Additional disclosure: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds.