Monday, March 7, 2016

Five Dividend Growth Investing Lessons I Have Learned Over the Years

The analysis of my past investments from 2008 to now has shown a few interesting lessons. The first is that I do not know which companies will be the best ones to own in the future, in advance. I can look at earnings per share and dividends per share trends, but in reality, noone can predict the future perfectly. Based on past experience, I can only deduce that a diversified portfolio of quality dividend growth stocks should do fine over a long period of time.

The second lesson is that I should not sell stocks merely because they have risen in price. I know I talked a lot about this before. The main reason is that I made this mistake by identifying and purchasing small stakes in companies like Sherwin-Williams (SHW), W.W. Grainger (GWW) and RPM International (RPM) in late 2008 and early 2009, yet I never added to those positions later on. The reason was because they were always slightly overvalued per my yield requirements. In addition, I also ended up selling those stakes a few years later, which in hindsight was not a great move. I ended up buying companies high higher current yields, which still did great, but not as great as the original companies.



The third lesson is again, to not chase yield. I think that my current entry rules, where I require a minimum yield of 2.50% is somewhat an exercise in yield chasing. I am imposing my will on what is available today, which is not a very smart strategy. If I simply took the dividend champions list, and then looked at growth in conjunction with yield, I will end up with a more robust list of candidates to potentially add to my portfolio. This is something I had intuitively done before, but I never really took the time to formulate more formally.

My review of the best dividend stocks for the past 50 years uncovered that many of todays dividend champions were having low yields. For many companies like Wal-Mart (WMT) or McDonald’s (MCD), they didn’t really yield a lot to their shareholders in their beginning. Yet, they managed to deliver outstanding yields on cost to their shareholders, who were patient enough to hold for 15 – 20 years.

The fourth lesson is that diversification matters. Many investors focus only on the absolutely best ideas, and trick themselves into believing that they will be able to select the best performers on a go forward basis. I disagree that this is a smart strategy for most investors out there, and would only work for a very tiny minority. Either way, my goal is to put the odds of success in my favor, and reduce the odds of failure - which is what diversification provides. I believe that a few companies I select will do really well, and compensate for the ones that don’t do well. The rest will do just fine. If I focus only on companies in the sweet spot, I may be ignoring companies that have high growth expectations and are available at attractive prices, but through no fault of their own are providing low yields. If I ignore those companies, my dividend growth portfolio may not grow income and value as much as it should be. It may be helpful to mix and match dividend stocks with different characteristics, in order to further bullet-proof my portfolio.

Continuing with the fourth lesson, everyone talks how they want to focus on their best ideas. I think in theory that works great. In reality, I never knew what my best ideas would be in the next 15 - 20 years. Looking at the companies I purchased in 2008, I would have never guessed that W.W. Grainger (GWW), Sherwin-Williams (SHW), Family Dollar (FDO), RPM International (RPM) or PPG Industries (PPG) will be the best ideas. I also foolishly never added to those, and even sold the smalls stakes in Grainger (GWW), Sherwin-Williams (SHW) and RPM International (RPM) because I thought they had gone up too much, and because I didn’t want to have too many companies in my portfolio. I believe this thinking was wrong on all three counts. I never invested in PPG Industries (PPG), which was a 5 - 6 bagger since I reviewed it in 2008. Many investors were talking how the best days of Altria (MO) were behind it in 2007 - 2008, and missed out on a 4 - 5 bagger in the process. along with its steady dividend raises. Even the venerable Dividend Aristocrat committee didn't believe in Altria - they kicked it out of the index in 2007.

The fifth lesson is to combine qualitative with quantitative analysis. I have talked about qualitative analysis before. This means that I look for companies that exhibit stability throughout the economic cycle. If I believe that earnings per share are somewhat recession resistant, I can have a higher conviction in my decision to average down in a stock.  The main driver behind dividend growth and long-term growth in business valuations is earnings growth.

Looking at my results, I think that the picks I made when I looked at quantitative factors were pretty good. However, those were quality companies where the numbers were showing a gradual improvement of business over time. When you have a quality company selling at attractive values, you have odds of success in your favor. It is dangerous to only look at qualitative or quantitative factors in isolation however. When only looking at qualitative factors, the risk is that I end up looking for things that support my thesis, which could make e violate the objective nature of quantitative approach. For example, while I believe that Coca-Cola is an outstanding business, it has been unable to grow earnings per share since 2011. This precludes me from adding money to this company, despite its record of growing distributions for 54 years in a row. I have also avoided several cyclical companies such as BHP Billiton (BBL) and Caterpillar (CAT), despite the fact that a few years ago their trends in earnings and dividends looked outstanding. This was because cyclical companies look best at the top of the cycle, but worst at the bottom of the cycle. Too bad I didn't apply these same sets of criteria on the energy companies.

That is because I believe these companies are cyclical in nature, and have only been successful because of the emerging markets booms of the past decades. Well, noone knows how long this boom will last, so maybe I should not be biased against them. I have also been biased against telecom companies, which have delivered slow growth, but their metrics have not been very promising. Other people are biased against retailers, and believe all retailers will have a hard time maintaining profitability because of the disruptive power of the internet. The reality is that not everything will go online, some retailers might be able to do business both online and offline, and the scare that retailers are going to have it difficult has depressed valuations. The one factual evidence that will prove me wrong in a retailer is when they cut dividends. This could be decades in the future, at which point I may have received my capital back in the form of dividends, spun-off shares and my original shares would have appreciated nicely. Just ask shareholders of Sears in 1993 how they did – pretty nicely for a retailer that was not doing well.

In this article, I have shared five investing lessons I have learned over the past 8 - 9 years. The purpose of these lessons is to remind myself what worked in my investing, and what didn't. The hopeful outcome is that I use these lessons to become a better investor. Perhaps the best lesson that led to the five in the first place is to be able to evaluate investments for recurring problems.

Full Disclosure: Long GWW, MO, WMT, MCD, KO

Relevant Articles:

Not all P/E ratios are created equal
Why the best investment plans never turn out as expected
Buying Quality Companies at a Reasonable Price is Very Important
Dividend Portfolios – concentrate or diversify?
Three Questions That Every Dividend Investor Should Ask Themselves

6 comments:

  1. DGI,

    Thanks for sharing your thoughts and these useful lessons. My biggest problem over the years has definitely been chasing high yield, particularly in energy. I agree with you when it comes to cyclical businesses, their numbers look phenomenal at the top of markets and absolutely dreadful near the bottom. If you are more aggressive, there's a time and place. If you want stable, reliable income, I wouldn't be turning to those cyclical companies.

    What are your thoughts on consumer staples? Seems like they have emerged as a safe haven play right now, so how do the valuations look to you? You mentioned KO, and recent earnings/revenue performances are always something to keep in mind.

    Cheers!

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  2. Thanks for stopping by FI Fighter. I try to share my mistakes, so that people can learn from them, and hopefully improve their investing.

    Congrats on your retirement. I am looking forward to reading about your adventures!

    DGI

    ReplyDelete
  3. Always look forward to your insights, DGI.

    While we are on the subject of sharing mistakes, last month I sold my small HD holdings (15 shares) at $120 - Bought in at $76 in 2014. A few analyst have them as a sell. My thought process is that Cons Disc will have a tough year in 2016 and that a small recession is taking place and will last into early 2017. I was also heavily weight in this sector. I also wanted to build up cash reserves to take advantage of a flash crash that I think will happen this year. I also sold some ITW and CMI to reduce my Inds. exposure and added OA and LMT. I've read a few articles recently, after the fact, that advised against this. In hindsight, I was playing with market timing. Foolish! With the exception of MO, DIS, O and AA, my DRiP's are now going to cash. As a result, I have about $4000 waiting to be deployed. I'm having to discipline my trigger finger. It's only been a month since doing this so maybe I shouldn't be so hard on myself.

    Thanks again and keep 'em coming.

    ReplyDelete
    Replies
    1. I am glad to have offered some insights. Perhaps I spend too much time monitoring business news, blogs, twitter and talking to others, when I should just sit back and do nothing investing wise - just letting the investments compound. I think we as investors just waste too much time on noise.

      Oh and I am actually spending my taxable dividends in 2016.

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  4. DGI,

    Although my investing career has been shorter than yours, I also have experienced some of these same lessons. On the others hopefully I can learn from your lessons, so I don't have to experience them myself.

    Thanks for a nicely written article!

    ReplyDelete
    Replies
    1. Oh, I am sure we will each have a lot of mistakes in the future. No pain, no gain, right? It's all good as long as mistakes are not repeated again ( or in my case more than 3 - 4 times )

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