Wednesday, November 3, 2010

Is Buy and Hold Dividend Investing dead?

Back in late 2008 and 2009 many investors were asking themselves whether it was worth it to be invested in the market. Business journalists and hedge fund managers were using this to question whether buy and hold was still relevant today. Now that the market has increased significantly since hitting its March 2009 lows, many investors are realizing that buy and hold still works. The difficult part of buy and hold investing is sitting through declines in the stock market, while being fully invested. Another problem with buy hold is that investors could start believing the hype that it would have been possible to “time the market" and exit at the right time, right after the market hit its highs, and thus become market timers. Many such investors are still in cash, thus missing most of the recovery in stock prices. It is very difficult not to succumb to the temptation of actively managing your portfolio, especially given the ease of access to markets over the internet.

The main problem with trading however is that if you trade you incur significant transaction fees and trigger tax liabilities that you otherwise would not have incurred with a buy and hold strategy. In addition to that, once you sell you can miss any big moves in the market. Another risk is that the company you purchase with the proceeds from the first investment could turn out to be a poor performer. Most investors will never be successful in timing the market, especially since they get scared at the bottom and greedy near market tops. As a result academic studies have found that most “active” individual investors tend to underperform the market averages particularly due to overtrading.

One positive thing behind buy and hold is when you purchase a stock and then give some time to your position to work in your favor. If you had done your research and purchased a strong brand with solid competitive advantages, such as Johnson & Johnson (JNJ) or McDonald’s (MCD) where the fundamentals are expected to improve over the long term, the exact entry price should not matter too much. As long as you do not overpay dearly for a stock by paying more than 20 times earnings, it shouldn’t matter whether you paid $55/share or $70/share. The most important thing is to be able to identify the solid company in the first place and then simply reinvest dividends, which would further compound your gains and magnify total returns.

In order to be able to sleep well at night however, the portfolio has to be properly diversified. In addition to that your stocks have to have strong competitive advantages, which would translate into higher earnings, dividends and stock prices over time. It is also important not to overpay for stocks. One of the primary reasons why the stock market has been flat over the past decade, despite solid earnings growth, is simply because it was much overvalued in the late 1990s and early 2000s. Many analysts are again trying to time what will happen in the next few months in the stocks market. Chances are they have no idea what they are talking about. The best solution is to pick at least 30 solid companies and hold on to them for the next few decades.

Some of the best companies which have solid business models that throw off enough cash to reinvest and grow the business as well as grow distributions include:

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 48 consecutive years. Over the past decade, the company has managed to increase dividends by 13.50% annually. Yield: 3.40% (analysis)

McDonald's Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 34 consecutive years. Over the past decade, the company has managed to increase dividends by 26.50% annually. Yield: 3.10% (analysis)

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 48 consecutive years. Over the past decade, the company has managed to increase dividends by 9.90% annually. Yield: 2.90% (analysis)

Exxon Mobil Corporation (XOM) engages in the exploration, production, transportation, and sale of crude oil and natural gas. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 28 consecutive years. Over the past decade, the company has managed to increase dividends by 7.10% annually. Yield: 2.60% (analysis)

Kimberly-Clark Corporation (KMB), together with its subsidiaries, engages in the manufacture and marketing of various health care products worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 38 consecutive years. Over the past decade, the company has managed to increase dividends by 8.70% annually. Yield: 4.20% (analysis)

Full Disclosure: Long JNJ, MCD, KO, XOM, KMB

Relevant Articles:

- Buy and hold dividend investing is not dead
- How to make money in dividend stocks despite WallStreet
- Dividend Investing vs Trading
- Dividend Portfolios – concentrate or diversify?

4 comments:

  1. Excellent point and totally agree!

    "As long as you do not overpay dearly for a stock by paying more than 20 times earnings, it shouldn’t matter whether you paid $55/share or $70/share. The most important thing is to be able to identify the solid company in the first place and then simply reinvest dividends"...

    That's my process!

    ReplyDelete
  2. I'm a believer that buy and hold is (still) a valid strategy, but dependent upon the quality of what you're holding. B&H of a broad index (eg S&P 500) seems to offer more from market diversification than from actual returns these days.

    That said, I think you can still take advantage of market ups and downs. For example, someone who bought 100 JNJ early this year might have been content to pay $63/sh, then a month later watched it drop below $58/sh. The person could use that opportunity to buy another 100 sh @ $58, but with the assumption that JNJ will eventually return to $63, and with the plan to sell the original 100 sh when it does. Assuming JNJ reaches $63 and the person does sell, then: the person pockets $500 in profit ($6300 proceeds - $5800 cost), but with no taxable gain if he sold the original tax lot. The cost basis has been reduced from $63/sh to $58/sh, which also increases yield on cost.

    This approach would recognize that one's original entry price may have been good at $63, but $58 is even better. Having a planned exit point, and getting paid dividends to wait, should take some of the emotion and speculation out of the picture. An investor might do this if he/she doesn't want to permanently hold a twice-as-large-as-planned JNJ stake, but is willing to do so for what is expected to be much less than "forever."

    ReplyDelete
  3. Mostly in agreement. 20 PE stuff is nonsense as PE ratio's are a very poor timing indicator except on rare market tops and bottoms, and even then mostly useless. Stuff of retail thinking. Major bear market bottoms in past stock markets have had the oveall PE around 6-7. Far cry from 20. Buy cheap, clear and simple.

    As for the average investor, yep, trading will usually lead to disappointment over the long haul However, one should be rebalancing their portfolio to trim overvalued fat and putting it into value, or perhaps even holding cash if little value can be found. I've seen far too many long term buy and hold investors, especially the ederly sell out of fear that their money can never be recovered, at the very lows. In a nutshell, your timing advice is broad and not suitable for everyone. A person 20 years of age has plenty oftime to recover, someone in their 70's does not. And yes, someone in their 70's should have less in stocks, but that is not always the case, especially with today's low yield environoment.

    Each investor has to determine themselves what their short risk tolerance, ie, how much am I willing to risk before I panic. That has to be balanced with their long term objectives. Most investors know what they wish to achieve on the long end, but few have the emotional ability to withstand the short term drawdowns that their LT. objective requires.

    ReplyDelete
  4. I don't think Buy and Hold is dead. As you point out, as long as you don't overpay for your stocks, you should be fine.

    MCD at its peak was trading 50 times its earning! No way a hamburger company can live up to that!

    Today, VZ is trading at over 200! What are people thinking?

    ReplyDelete

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