How To Buy Low And Sell High: Dividend Strategy

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Includes: AAPL, ADP, AFL, BAC, ED, JNJ, LOW, MCD, MMM, MO, MSFT, PG, T, TXN, WFC, XOM
by: Financially Free Investor
Summary

What if we could buy low and sell high on a consistent basis? We will explore.

We discuss a systematic and rather conservative strategy to buy low and sell high using DGI stocks.

The strategy provides more than 14% annual cumulative return over 24 years vs. just about 8% from the S&P 500.

Sure, this would be the dream of most investors, to be able to buy low and sell high on a consistent basis. However, it is easier said than done, and most folks fail to achieve this. As a matter of fact, for retail investors, the opposite may be true. According to the 2017 report of Dalbar's Quantitative Analysis of Investor Behavior (QAIB), the average equity investor earned a net annualized rate of return of 4.88% for the 10-year time period ending Dec. 31, 2017. The long-term returns were slightly better. The 20-year annualized returns came in at 5.29%. However, when you consider the fact that the average investor is invested in a blend of equities and fixed-income funds, the performance over 10 years and 20-years period come to much lower at 2.52% and 2.58%, respectively. This compares quite dismal in comparison to the S&P 500’s 8.50% and 7.20% over the same periods.

Anyone can get lucky some of the time by buying and selling a stock at the right time. However, can we do this on a consistent basis? At the first instance, it sounds like market timing, and it's widely known that most folks lose money trying to time the market. So, certainly, we do not recommend market timing. But also we believe that there are ways that could allow you to buy low and sell high without market timing. Most of these methods fall into the realm of a systematic investing approach. The main advantage of a systematic approach we see is that it eliminates the emotional response or decisions during both good times and bad, especially during market corrections or crashes.

We first wrote an article on this topic almost a year ago, introducing a systematic approach that may allow you buying low and selling high on a consistent basis. We wanted to re-visit this topic, first for the benefit of new readers, and secondly, we wanted to see how the system worked during the last year and as a whole since 1995.

Who Should Use This Strategy?

We want to clarify that the strategy discussed in this article may not be suitable for everyone. We could broadly divide the investors into three types. We are not including traders in our definition of investors.

Most Passive Investors:

Most passive investors should stick to investing in broad indexes or ETFs, and if they can tolerate the market gyrations, over time, they will do just fine.

Passive-Active investors:

These are the investors who are basically in the middle. Even though they are passive due to lack of time, expertise or any other reason, but they still like to invest in individual stocks. We think these investors should stick to DGI investing, meaning investing in large, blue-chip, dividend paying, and dividend growing companies and holding them for long durations. They also could invest a small amount of capital in growth companies.

Active Investors:

These are the investors who like to be on top of their investments. For some, it may even border on a part-time hobby. They always are in search of alpha in the market. They are open to looking at and trying new strategies.

Normally, we advocate investment in multiple strategies for such investors. By combining many strategies, we are able to bring diversification, improve returns and reduce the overall volatility and risks. Not all strategies are going to behave in the same manner at all times. When one strategy zigs, some others will zag.

With this spirit of looking for alpha, we are always experimenting and backtesting new ideas. This article is also about sharing this new strategy.

Buy-Low Sell-High Strategy (OTC:BLSH) Using DGI Stocks:

Assumptions:

  • It may be best suited for folks who are in the accumulation phase and are still 10-20 years away from retirement. That said, it can still be used by anyone who is investing regularly in the stock market.
  • This strategy may not be suitable for people who already are in the withdrawal phase since they will be only selling a majority of the time. However, if they only withdraw the dividends, the strategy could still be good.
  • This strategy does not require you to invest all of the money up front in lump sum. It would require you to invest gradually over a period of time, likely many years. The strategy would not compare or work well if your goal was to invest the entire amount in lump sum upfront.

Buy Strategy:

The strategy will invest for the long term in the following kind of stocks:

  • The companies are fairly large, having a market capitalization of at least $10 billion.
  • The companies pay a good dividend and have a dividend history of at least 10 years.
  • We want to fill at least half of our portfolio with dividend aristocrats (or champions) - those that have at least 25 years of dividend history with continual dividend growth.
  • For the rest of the portfolio, we should look at companies that may have a shorter dividend history, but still, we would want at least 10 years of history. For example, if we were going to construct a portfolio today, Apple Inc (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT) would fit the bill. They have less than 25 years of dividend history, but all indications are that they will continue to pay and grow their dividends.

For each stock, on a daily basis, we will calculate the average price of the previous 252 days (which is approximately one year in terms of trading days). We multiply this average price by a factor like 0.90 or 0.85 etc. giving us the “target price.” We will call this multiplication factor the “Buy-Low-Factor.” We will provide the details below as to how we determine this factor. Thereafter, at the end of each day or week, we will compare the current price with the target price. If the current price is lower than the target price, we will buy the next lot of shares. We also determine the maximum number of shares that we want to have in any single company.

Buy-Low Factor:

For any given stock, we should look at the annual volatility. For low volatility stocks, the Buy-Low Factor would be 0.90. For medium volatility stocks, it should be 0.85. Even though our strategy will rely mostly on low or medium volatility stocks, if we have a high volatility stock in our portfolio the Buy-Low-Factor will need to be 0.80 or lower.

Example:

Stock: Proctor & Gamble (NYSE: PG)

Volatility: Low

Buy-low-factor: 0.90

Initial shares: 100

Incremental shares: 100

Maximum shares: 500

Sell Strategy:

The "sell" strategy is optional. If the investor really believes in the stock/company and wants to retain the investment for the long term as buy-and-hold, there is no need to adopt the "sell" strategy. Investors who may like to sell partially when the prices are high, and valuations may be rich, should adopt this "sell" strategy.

As in the buy strategy, for each stock, on a daily basis, we will calculate the average price of the previous 252 days (approximately one year in trading days). However, we will use multiple criteria to determine the sell decision.

  • Current shares match the target-allocation
  • And current-price > 1.15 times 252-days-average-price
  • And current-price > 1.10 times last-buy-price (most recent buy)
  • And current-price > 1.50 times our average-cost-basis in the stock.

When all four conditions are met, we will sell only a partial quantity (generally the same number of shares that we bought last time). As you see the “sell” strategy is more strict compared to the “buy” strategy, however, the "sell" strategy could be flexible depending on the investor. Some investors may not like to sell at all and may just use the buy-and-hold approach. Some others may like to sell a partial quantity if a position has become overweight in the portfolio and thus may like to reduce the exposure.

Example:

Stock: PG

Volatility: Low

Target allocation: 500 shares

Sell-high-factor: Combination of three criteria.

No of shares to sell in one lot: 100

Back-Testing (1995-2019) Results

Stock Selection:

The strategy will have no meaning if it does not show promise in the back-testing results. For our back testing, we first selected 12 stocks. The stocks were selected from many sectors/industries, though they are all solid blue-chip companies with a long history of paying dividends. Since our period of back-testing is 1995-2019, we have to think about what stocks should we have bought in 1995. Many of the well-established dividend companies of today (like Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL)) had not started a dividend payment policy in 1995. Obviously, it will be almost impossible to eliminate a selection bias entirely, but we have made an effort to look at the companies as if they had met our criteria back in 1995.

To further debunk the selection bias, we will add two stocks to our list that did not perform very well during the 2008-2009 financial crisis. They are Bank of America (BAC) and Aflac Inc (AFL). Even though both companies had paid dividends for a long time, and one of them (AFL) is actually a dividend aristocrat, so they would have otherwise satisfied our selection criteria. BAC was dragged down due to the subprime mortgage crisis to the extent that its survival was at stake. It eventually survived and recovered, but its share price still trades below its pre-recession level even after 10 years of the current bull market.

The second company, Aflac, was the worst of the dividend aristocrats in terms of drawdown during the 2008-2009 crisis. Its share price dropped by about 80%. However, it has recovered during the following years.

Out back-testing model kept the same 14 companies for the entire period of roughly 24 years. However, in a real-life portfolio, one could add new companies from time to time and keep the portfolio well diversified and balanced.

List of selected stocks:

Symbol

Company Name

Sector/Industry

1

ADP

Automatic Data Processing (NASDAQ: ADP)

Business Services

2

ED

Consolidated Edison (NYSE: ED)

Utility

3

JNJ

Johnson & Johnson (NYSE: JNJ)

Healthcare/ Drug

4

LOW

Lowe’s Companies (NYSE: LOW)

Retail/Home Improvement

5

MCD

McDonald’s Corp (NYSE: MCD)

Restaurants

6

MMM

3M Co (NYSE: MMM)

Industrials

7

MO

Altria Group (NYSE: MO)

Tobacco

8

PG

Proctor & Gamble ( PG)

Consumer defensive

9

T

AT&T Inc. (NYSE: T)

Telecom Services

10

TXN

Texas Instruments (NYSE: TXN)

Technology/Semiconductor

11

WFC

Wells Fargo & Co (NYSE: WFC)

Banking

12

XOM

Exxon Mobil (NYSE: XOM)

Energy

13

BAC

Bank of America (BAC)

Banking

14

AFL

Aflac Inc

Insurance

Back-testing: Buy Low and Sell High Strategy

We will buy up to 500 shares (only 100 shares at one time) of any one stock before initiating the sell strategy. If the number of shares falls below 500, no sale will occur, and we will buy at the next opportune time as per the strategy. The back-testing model assumes that we started investing in January of 1995 and ran the model until March 8th, 2019.

Rules and Assumptions:

Period of testing: January 1995 – March 8, 2019

Buy rules:

  • Buy the first 100 shares of each stock on the first day of the test period (Jan. 3, 1995)
  • Buy any subsequent shares when the current price is less than 90% of the average price of the past year (that is 252 days).
  • Also, after the first buy, all subsequent purchases will be at least 252 days apart.

Sell rules:

  • Do not sell unless the total shares in a company have reached 500.
  • Sell only if the current price is > 1.15 times of the average price of the past year (that is 252 days) and > 1.10 times the price of last (most recent) purchase and > 1.50 times the average purchase price of the stock in our portfolio.

The system will run the check for buy and sell signals on a daily basis using end-of-day data.

Below are the tables of buy-sell transactions as determined by our system during the period from 01/01/1995 until 03/08/2019 for each stock in our portfolio. Prices shown are split-adjusted prices.

( ADP)

( ED)

( JNJ)

( LOW)

( MCD)

( MMM)

( MO)

( PG)

( T)

( TXN)

( WFC)

( XOM)

(BAC):

(AFL):

Performance:

Below is the performance of the portfolio (with 14 securities) assuming all dividends were reinvested in the respective securities.

Model

S&P500

3-Year Annualized Return

9.27%

11.86%

5-Year Annualized Return

12.79%

8.50%

10-Year Annualized Return

16.66%

14.30%

Since 1995, Annualized Return

14.09%

7.95%

Performance without BAC and AFL:

Currently with both BAC and AFL included the performance since inception was 14.09%. However, the performance with 12 stocks, excluding the BAC and AFL, would have been only slightly higher at 14.34%. (just about a quarter point more). It shows that we could add a couple more under-performers, and the overall impact will be very small as long as the majority of the stocks are reasonably good picks.

Amounts invested over the years in the 14-stock portfolio:

Year Purchases Sales Net Amt.Invested
1995 18000 0 18000
1996 5682 0 5682
1997 5558 0 5558
1998 13187 0 13187
1999 19091 0 19091
2000 33458 0 33458
2001 28348 0 28348
2002 32082 1600 30482
2003 4926 21658 -16732
2004 9282 5985 3297
2005 7230 6023 1207
2006 18264 8730 9534
2007 14469 12676 1793
2008 38098 3493 34605
2009 3190 11146 -7956
2010 8551 10171 -1620
2011 20149 21705 -1556
2012 11738 3169 8569
2013 0 32680 -32680
2014 2826 0 2826
2015 42574 11087 31487
2016 11237 65174 -53937
2017 6223 16633 -10410
2018 69015 9649 59366
2019 0 0 0
TOTAL 181599

With a net investment capital of roughly $180,000, invested in 14 stocks over the years, it grew into a large sum of over $1.5 million over 24 years, providing a CAGR of roughly 14.09%.

Conclusion:

This portfolio is based on a predetermined, systematic approach. The portfolio does not require the entire investment up front but allows us to invest periodically at different times. The system is flexible, and we can decide how much we want to be invested in each stock. We also can see that even if we were to select a few stocks that may not do very well, the overall results would still have been outstanding.

Over a period of 24 years, we had on an average 10 transactions for any one stock. In total, we had a total of 144 transactions (106 purchases, 38 sales) for 14 stocks over 24 years.

We will admit, the stock selection process (for back-testing purposes) may have some selection bias, but we also picked stocks that performed to varying degrees at different times. For example, Exxon Mobil hasn’t done much in terms of share performance since October 2014. Bank of America had especially terrible performance during and after the financial crisis. Even Altria hasn’t done very well in recent years. But that does not stop the overall portfolio to provide excellent overall long-term returns.

Essentially this portfolio strategy uses the concept of dollar cost averaging (DCA), but instead of buying at a regular interval, it only buys when the price is relatively cheap and sells when the price is relatively high. We will like to emphasize that more work and research may be needed to gain confidence in the strategy. The idea is to provide a basic framework to do further research and due diligence to formulate a coherent investment strategy.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LYB, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, JPS, JPC, JRI, TLT. 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: Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. The author is not a financial advisor. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. The stock portfolios presented here are model portfolios for demonstration purposes.