The following is a guest post of Mike McNeil, founder of Dividend Stocks Rock. Mike is a passionate investor managing his own dividend growth portfolios since 2003. He started writing on his site in 2010.
Are you struggling when it's time to buy or sell your stocks?
I found a way to know exactly when to make my trades and avoid this painful moment of dilemma. Am I buying too high? Will the stock market crash and I will miss a great buying opportunity? Is it time to cash my profit before it all goes south? I once had those questions going through my mind all the time. I'm now done with them and I will share how I do it with you. I'm not a guru and I don't have a crystal ball. I just found the right solution to this problem.
I remember when I started investing in the stock market. This was back in 2003. Right after receiving my first paycheck for my first job after graduating, I opened a brokerage account. Since I started my career in the financial industry, I knew that the products my advisor would offer me would be very good and paying... for him! This is how I started my investing journey on my own since day one.
Unfortunately, I rapidly discovered investing in the stock market is not as sexy as it looks. It requires lots of time and effort understanding financial statements to build a solid portfolio. And even when you do everything right, the market could throw it all down the drain with one of its many market crashes. Then the doubt hits you; is it the time to buy? Is it the time to sell? I have money waiting in my account, when do I enter the market?
The answer to stop struggling when it's time to trade
When I started investing in 2003, everything seemed easy. Between 2003 and 2008, the market did nothing but go up. A monkey could have replicated and beat my return. However, we all know what happened next and the stock market has never been the same since the big credit crunch.
This event got me thinking and I've exhaustively reviewed my investing process. The truth is that I was quite young when I started investing (22) and I didn't realize how important it was to have an investment process in the first place. After a couple of years or reading academic studies, acclaimed investing books and from my own experiences, I've built my own set of investing rules; the 7 principles of dividend growth investing. They have been clearly established since 2012 and they helped me going through the past four years with great success as I successfully beat my benchmarks four years in a row.
The sixth principle is all about the timing to buy or sell a specific stock. First of all, it has been clearly determined by several financial studies that time in the market is a lot more important than timing the market. This statement is even more stronger among dividend growth investors. The longer time you stay in the market, the higher dividend payouts you receive. Therefore, the best timing to buy any kind of stock is…now. I know, this sounds (and is) a bit simplistic. This is why there is more to my technique than simply "buy now".
The investment thesis is the core decision maker
While "now" is always the right timing to buy a company, it doesn't mean it is always the time to buy any company. This is when the investment thesis comes into play. You may want to use various stock filters and criterion to build your own watch list or buy list. Depending on your investing goals and your own perception of the stock market, we could debate a while about which fundamentals are the most important when selecting your next purchase. However, one thing we must agree is that only trade based on strong investment thesis has a chance to be successful. This statement is at the foundation of the 7 dividend growth investing principles.
In other words, I don't think it matters which numbers your look at before buying. What really matters is how far you went to determine the reason why this company and not another should be part of your portfolio. If your investment thesis is well detailed and makes complete sense, there is very little room for a potential catastrophe once you pulled the trigger add this stock to your holdings.
Writing down your investment thesis is an exercise that sounds quite simple, but many investors decide to ignore because of lack of time or simply because they can't formulate a strong thesis. Nonetheless, this technique should be at the center of your decision-making process. Once you have determined a strong set of reasons why you should purchase shares of a company, the doubts made by the fact it is trading at its 52-week high or that the market has been going up for a few years will disappear.
For example, this is how I decided to buy Disney (NYSE:DIS) back in 2012. While Disney was trading at its 52-week high, I decided it was still the right timing to add this company to my portfolio. Here's my investment thesis back then:
"DIS has become more than entertainment parks and Mickey. It is now the largest entertainment business in the world. Walt Disney is divided into five different segments: Media Networks, Parks and Resorts, Studio Entertainments, Consumer Products and Interactive. The Media division (ABC, The Disney Channel and ESPN) leads DIS revenue shares with 44% of the company total sales."
Disney has proven analysts wrong by showing revenue growth for its Media division. Many analysts issued concerns over the summer of 2015 with regards to the declining number of cable users. However, ESPN has put its expenses under strict control and keeps showing revenue growth potential. The other divisions will benefit from the US consumers spending more, especially with the coming of the new Star Wars trilogy. Finally, Disney is the strongest brand for family entertainment and this competitive advantage is nearly impossible to replicate. The opening of a new theme park, Disney Shanghai, will also contribute to boost revenues in the years to come. Disney is a strong money-making machine generating over $1.3 billion in free cash flow quarterly.
The next four years proved me right as DIS easily beat its 52-week high of the time and continues to pay increasing dividend payouts at the same time.
The right time to sell follows the same rule
Now that Disney is making over 80% return in four years in my portfolio, the question that kills is when is the right time to sell? Following with my example of Disney, it seems the stock price has recently stagnated and left me with poor results over the past 18 months:
Is it time to get rid of Disney? After all, I made enough money to make me happy and I could cash my profit before the market turns it back on me. This could certainly be an option, but it would leave me a sour taste in my mouth if I discovered three years from now that DIS has soared again upon strong financial results. After all, those who decided not to buy or sell the stock in 2012 is facing this unfortunate truth.
Instead of looking at my paper profit or loss, I use the exact same rule to sell any of my holdings that I used to buy them in the first place; I review and validate my investment thesis. Therefore, as long as Disney will meet facts included in my investment thesis mentioned above, I will keep this company in my portfolio. When you think about it, the only reason to sell a company would be that it doesn't show the promise it once did, right? In the event Disney doesn't meet my investment thesis anymore, it will automatically be sold.
Unfortunately, this will not avoid all mistakes
This technique will obviously not guarantee that you make money each time you make a trade. We are all humans and if our assumptions are wrong in the first place, the company will never succeed in validating one's investment thesis and the trade will result in a loss.
However, what this technique will do for you is that it will eliminate the doubt in your mind when you are about to pull the trigger. Doubts will often result in paralysis and no trades are made. You then leave money in your money market funds for months, read years without investing a penny.
You then lose hundreds or thousands of dollars in dividend not paid. On the opposite, the same doubts will make you keeping a loser for several years preventing you from investing your money wisely in another growing company instead.