Three years ago I decided to invest some of my money in stocks. My bank paid out a lowly 1.5% interest at the time and I had read stories of top investors buying stock low and selling high, playing the market and raking in 10-20% in profits each year. How hard could it be?
The clueless investor
I started out buying stock in Fugro and VMH Moët Hennessy Louis Vuitton. I was a bit late with my purchase, both stocks had recently dipped low and were already rising again. I figured I would "ride" the stock to the top and sell quickly before they dipped again.
Unfortunately that didn't quite work out the way I expected. Fugro bounced widly up and down at around €40 per share making a neat exit impossible. And right after I bought Moët Vuitton for €117 the stock dropped below my buying price and stayed there for a long time. My portfolio was going nowhere.
A year later I decided to take the words of Warren Buffett to heart: only invest in companies whose business model you understand. I liquidated my positions and used the money to buy stock in Apple (NASDAQ:AAPL) and Tesla (NASDAQ:TSLA).
Before I knew it my Apple position had gained more than €2500 in value. This was in September 2012. I considered selling but decided to wait a little longer. Seven months later Apple had lost 45% of its value.
Tesla had been growing explosively since March 2013. I got in at around €160 but just after my purchase Elon Musk admitted that the stock was overvalued. The growth immediately fell flat. Two months later Tesla was trading at €120 per share.
Timing the stock market is hard. I was naïve to think I could time my buying and selling just right and earn a 10% profit. I was competing with trained financial professionals who do this sort of thing every day and who have access to insider business information to guide their decisions. I just had my newspaper, a gut feeling and a cheap Binck trading account.
In my enthusiasm I forgot an important lesson, again by Warren Buffett:
"Investment is an activity of forecasting the yield on assets over the life of the asset. Speculation is the activity of forecasting the psychology of the market."
In other words - trying to make money from short term price movements is speculation. Buying and holding stock for the entire lifetime of a company is investing. I needed to start thinking long term.
I realized that my stock price speculation was not passive income. My portfolio had a value on paper but I needed to liquidate my positions to turn that value into cash. So to earn an income I needed to continually buy and sell positions.
Dividend Growth Investing provides a passive income that grows exponentially each year and simultaneously builds net worth over the long-term. Wealth is not simply about having lots of assets, it’s also about generating a significant amount of passive income that grows over time. Dividend Growth Investing works to build both passive income and net worth, it can be more reliable than other investing methods, it requires less time, and it can be performed by anyone with a little discipline. Ultimately, I decided to develop a Dividend Growth Investment strategy for myself.
After taking a long hard look at my life I can't help but feel that I have handled my finances all wrong in the last decade.
Let's go back in time 14 years to my younger 30 year old self. He had three times as much in the bank as I have now and was just about to launch a startup. He was nervous about income and so he held on to his bank account as a backup in case the startup failed.
With the help of my time machine I would tell my younger self:
You are going to have a great time with your startup. But don't keep your money in the bank, invest it in dividend growth stocks instead. Use the dividend to back up your startup income and in 14 years the compound growth will make you wealthy regardless if your startup succeeds or fails
Unfortunately I don't have a time machine. But I do have a comfortable income today, enough to buy a couple of dividend growth stocks each month. I am on track to eventually retire and live entirely from my dividend income.
Dividend growth investing
For dividend growth investing I need to find high quality, stable and mature companies that pay out a steadily rising dividend year after year. To take advantage of compound growth I need to hold on to these companies for at least 10 years, so I am looking for companies with these characteristics:
- 10-year unbroken positive dividend growth
- 10-year unbroken positive revenue growth and profit
- a healthy balance sheet, no excessive debt
- a strong focus on increasing shareholder value
- a fair share price
- a good competitive position
There are surprisingly few companies that qualify. For example: out of the thousands and thousands of listed companies on the American stock exchange only ±500 have an unbroken 10-year positive dividend growth.
Finding the few companies that qualify can be like finding a needle in a haystack. So how do I do it?
I use this 4-step method to quickly analyze a given company:
Stock screener: I use a stock screener to quickly weed out all the volatile and underperforming stock that is not suitable for dividend growth investing.
Fundamental analysis: I download the company balance sheet and financial key performance indicators and run the numbers. I look for increasing revenue, earnings and dividend, healthy debt position and a fair stock price.
DDM valuation: I use the results of the fundamental analysis to determine a fair price and compare that to the current stock price. I want the current price to be equal or lower than the fair price.
News check: I google for news articles about the company. How are they doing, what are their competitors, and what do other financial analysts think of the company?
When a company passes all 4 checks I put it on a to-buy shortlist, take a few days to think it over and then make my decision to purchase or not.
A stock screener is a tool that investors and traders use to filter stocks based on user-defined parameters. Screeners let investors and traders analyze hundreds of stocks in a short period of time, making it possible to weed out those stocks that don't meet the user's requirements.
I don't use a tool but a list: the Standard & Poor's Europe 350 Dividend Aristocrats. The list contains companies in the S&P Europe 350 index that have increased dividends for at least the last 10 years and have a market capitalization of at least $3bn.
Another list I use is the Standard & Poor's Euro High Yield Dividend Aristocrats. This is a list of companies in the S&P Europe BMI index that have increased dividends for at least the last 10 years and have a maximum dividend yield of at least 10%.
Companies on these lists have a 10-year unbroken string of rising dividends, a very strong indication that they are healthy, that they are growing and that they place a very strong focus on shareholder value.
By only considering stocks in companies that pass through the screener I weed out the 99% of stocks that are too volatile to use for dividend growth investing.
Next I perform a fundamental analysis by looking up the company balance sheet and running the numbers. I will discuss my method in more detail in Part 2 of this series.