Friday, March 27, 2020

Bear Market Playbook

I wanted to share an insightful commentary from a friend of the blog, Joe Ferris, who is a Registered Investment Advisor at Summer Fields Investments,LLC. I have discussed dividend investing with him for over a decade. His clients received the following email last week, which I am republishing with permission. I found it insightful, and believe that readers will find it helpful.

Dear friends,

After a lengthy bull market, it appears that we are now entering a bumpy market and for now, a bear market (typically defined as a drawdown of over 20%). If this virus passes faster than the market thinks, it could be very positive for the second half of the year as low interest rates and low energy costs would be very stimulative to the economy. Both JP Morgan and Goldman Sachs have predicted a very weak second quarter, followed by a strong third and fourth quarter of the year.

However, if the spread of the virus ends up taking more time to resolve positively, it might cause stress on the credit markets and on the economy, and the market seems to currently be scared of that.

I will get right to the point. What am I doing with the portfolio that I have nurtured for the past 25 years? I am not changing my current approach. I am waiting this out. Bear markets last for about a year or so on average, and have occurred 32 times in the last century. While they are happening they feel absolutely awful. We check the news and the sky is falling and everything seems to be negative, at times confirming what we think our fears are. However, the skies ultimately clear, investor panic ends, and the path resumes for further economic growth and continued innovation.

A premise of our investing has been that 2008 was similar to the Great Depression, and the Fed treated it so. Their TARP program and other actions caused banks to be better capitalized. Typically, that kind of structural trauma happens once in a generation. Resolving some of that structural imbalance should cause smoother ground going forward. The US consumer has also been very strong with relatively low household debt, until the virus happened.

Although we are drawing down significantly here, with the Dow Jones down 32% from the highs and the industrial, financial, and energy sectors down 35%, 38%, and 55% in the past month alone, this is not a structural event that the markets are trying to price in. This is a transitory virus that will hopefully be dealt with sooner than later, and pent up demand and consumption will most likely return. There is also the energy price war between Russia and Saudi Arabia which is not sustainable either, as both of their breakeven costs are significantly higher than energy prices currently.

However, the stimulus and fiscal policies the central banks and countries are currently indicating could end up being very good for the economy, as seen in this graphic:


So there is reason to be very optimistic going forward.

Why not "sell everything at the top"? First of all, timing these things is nearly impossible because the markets reaction can vary wildly. Second of all, many of our consumer staples are now up very nicely. It is very hard to predict share price action.

An example: Because of fears of Amazon dog food and other issues, General Mills went from 70 in 2016, to 38 in late 2018. Now it is back up near 60. Anyone who held General Mills has already experienced a major bear market, experiencing a drawdown of 45% until it came back up with good sentiment and fundamentals.

I would venture to compare General Mills to our entire portfolios. There are doubts and fears about the economy, but it should find its way through just as it has in past bear markets. Central banks are very concerned that the economy makes it through this malaise and pandemic, which certainly took everyone by surprise.

The most effective way forward, in my view and experience, is to stay the course and hold through the drama. We can collect the dividends and either use them as retirees, or reinvest them for those in the accumulation phase. This too shall pass as the many bear markets that the world and the US has experienced have shown us.

Every bear market is different. In 2008, you could still go to Starbucks even if you didn't have a job. Now, it is challenging to even go out, for the time being, under quarantine. This will effect lodging real estate directly and we can expect some dividend reductions in hotels. Low energy prices might see some dividend reductions there until a final washout in shale, resulting in higher prices and more consolidation, which will result in higher energy prices and more profits. I am not expecting large reductions in aggregate in the sector, but preparing for some.

However, I do not want to sell these positions because they are high quality and when their sectors do well, we will likely be highly rewarded. As we have discussed, energy is also an effective inflation hedge, and central bank printing will probably result in higher inflation down the line. I also expect dividends to remain robust in aggregate for the year.

This is why we diversify. Experiencing a big drawdown is not pleasant, but it is as natural as the weather. Sometimes, the mood is euphoric, and other times, the mood is downcast. By staying the course and holding through the volatility, we will be able to reap the rewards of business ownership.

We are seeing a lot of stimulus from all central banks which should be bullish in the short term. However, longer term, the market will probably want to see the virus peak and fall. That will probably be a good sign that the drama has lifted.

Finally, people are curious if they should add or pull back on investing. I think that continuing to average into the markets if possible is the most effective way of dealing with them on a long term basis. We don't know if the economy will boom back up in the second half, or if it will continue to consolidate and rebase further down the line to future growth.

Where is the bottom? Hard to say. The markets might remain chaotic until we get an indication the virus has peaked. We could fall 15% further according to some technical analysts. In the Spanish Flu of 1918, I recently read that while the market was only down 10% 4 months after its start, the interim drawdown was 37%. Currently the Dow Jones is approximately 33% down from the highs of the year. Maybe we will only fall 4% more.

The only way I know, is to hang tight and ride the drama out. I have done so in 2008, experiencing a 50% drawdown which ended up much, much higher in the long run. I have also done so in Fukushima nuclear meltdown in Japan, Eurobond crisis, taper tantrum, earnings recession, energy crash of 2016, etc. My dividends received have also improved mightily over time.

Just because there are external events that are chaotic, it doesn't mean that I should sell good businesses. It is also worth mentioning, that just because a business is volatile, that is not a true reflection on its intrinsic value. There are many factors here at play, including PTSD from 2008, new investors who have never experienced this type of volatility and are selling fearfully, lack of clarity around this virus and fear exacerbated by social media and the press, election year anxieties, free trading causing less friction between buying and selling, index funds dragging down whole sectors, margin calls, and so on. But by owning good businesses for the long term, we end up with a nice income in aggregate and pieces of ownership in some of the best businesses in the world. I am excited to continue to invest with you for the long run. Best regards, and please keep healthy and safe.


Sincerely, Joe
https://www.summerfieldsinvestments.com/

Wednesday, March 25, 2020

Dividend Investing and Covid-19 Disruptions

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

― Benjamin Graham

The price of securities fluctuates more widely than the change in underlying fundamental values, such as dividends and earnings. I generally ignore price fluctuations, unless I can take advantage of any bargains.

Based on some limited sample conversations and interactions I have had, I wanted to share my viewpoint today. I think that this virus is dangerous, and the economy is experiencing something it hasn't experienced before. But I still believe that stock prices move more than the underlying intrinsic values of a business. Buffett defines intrinsic value as the sum of total cashflows you will receive from a business from now until the end of time. For the purposes of this exercise today, I am looking at dividends, which are cash flows in your pocket. And I use Johnson & Johnson as an example to walk you through my reasoning as to why I believe the stock price declines are higher than any potential decreases in intrinsic value for dividend stocks in general. While some will not survive, a lot will, and their profits should more than compensate for the losers in a diversified dividend portfolio. This has always been the case.

I also try to make the case that a disciplined investor should do well, as long as they keep to their plan of regular investment every month, building diversified portfolios, keeping costs low, reinvesting dividends and staying the course. This plan worked even during the Great Depression. This is the model I use in my investing newsletter, in order to reach dividend investing goals.

Let's start this by reviewing Johnson & Johnson, a dividend king with a 57 year history of annual dividend increases. Johnson & Johnson (JNJ) paid $3.54/share in 2018, $3.75/share in 2019 and is on track to pay $3.80/share in 2020. The price of Johnson & Johnson has fluctuated widely at 42.10 to 33.50 times dividends in 2018. The range was 39.40 to 33.33 times dividends in 2019. So far in 2020 the price has fluctuated between 40.66 and 28.72 times dividends.

And if you think that there is some logic to these ranges, Johnson & Johnson sold between 38 and 24.90 times dividends in 2017, and paid $3.32/share.

The prices move a lot more than changes in fundamentals, because stock market participants are a fickle crowd. Their perceptions change based on fear and greed, expectations on the economy, alternative investments, the treasury yields etc. And that is a generally wide fluctuation on true stock values for a company like Johnson & Johnson which is generally considered to be defensive and somewhat predictable.

JNJ
2020
2019
2018
2017
Price to Dividends
40.66
39.42
42.09
37.97
Price to Dividends
28.72
33.33
33.51
24.93





JNJ
2020
2019
2018
2017
Dividend Per Share
 $  3.80
 $   3.75
 $   3.54
 $   3.32
High for the Year
 $154.50
 $147.84
 $148.99
 $126.07
Low for the Year
 $109.16
 $125.00
 $118.62
 $82.76


Imagine what happens when there is extra uncertainty added to the perceptions of Mr Market on the stability of earnings and dividends. The ranges get out of control in the short-run.

Enter the situation over the past month, where the spread of Covid-19 outside China is causing widespread disruptions in the world economy. It seems like we are only getting started too, which gives everyone a ton of anxiety.

With the shutdown of a large part of the US economy, people in quarantine, and cities shutting down, we are seeing some visible economic disruptions. We will see high unemployment, and a lot of businesses going under, as the economic activity grinds to a halt. No one knows how long this would last for. It is a scary time. It feels as scary as the 2007 – 2009 financial crisis, The Great Depression, World War I and II combined with the Spanish Flu of 1918.

I do believe that financial information we see such as numbers on earnings, GDP, will look very volatile for at least Q1 and Q2 of 2020. I am hopeful that by Q3 and Q4 we will see a rebound from the disruption. A lot of businesses and consumers may not make it through this crisis, which is why the US government is stepping up its efforts to take a bigger role in the economy through a variety of methods within its toolkit. That would soften the blow, but we are still in for a rough ride.

The companies that survive this epidemic will see their fortunes rebound. They will continue delivering higher earnings and dividends to their long-term shareholders who stick with them through thick or thin.

The most important thing is for your company investments to survive, even if it means a few messy quarters that look absolutely horrifying.

Now is the time I need to remind you that you are investing in equities not for the next quarter or two, but for the next 20 or 30 years. As such, based on historical activity, you would have learned that recessions do happen at least once or twice per decade. In addition, stocks tend to drop by a lot a few times per decade, and crash several times per century. The most frustrating part is that each crisis looks different than the past. In addition, while stocks have delivered annualized total returns of 10%/year since 1926, their year to year returns have been very volatile and all over the place.

The value of the stock is the amount of future dividends you will receive from now until the end of time.

If you will hold a stock for 30 years, and it will pay a dividend of $2/year, it should be worth roughly $60/share. If the operations are disrupted in year one, and it earns zero but the business is intact and future business prospects are intact, the amount of dividends will be $58. If there is a catch-up to $2.07/share for 29 years, the value of the business should be unchanged. This is a concept called dividend payback, which I last discussed a decade ago.

You can argue with me that I should use a discount interest rate of 5% or 10%, to discount those future values to the present. I would argue back that interest rates will likely remain low for quite some time. I would also argue back that my analysis doesn’t assume any growth. So if earnings per share and dividends per share grow by 5%/year for 30 years, and I discount at 5%, then I am back to $2/share.

Obviously this is a rudimentary model for evaluating long-term value of dividends received by companies. The other thing to consider is that with dividend stocks, on average, I would expect to receive my original purchase price back in the form of dividends within 15 – 25 years from the time of investment. I would also expect that a diversified portfolio of these businesses will have a value at that time as well. For example, if you look at the S&P 500 and its dividend history, you can see that investors have managed to get their money back in the form of dividends within 15 – 25 years, and still own a diversified portfolio of growing companies as well.

If I look at a company like Johnson & Johnson (JNJ), I see it selling for $120/share today. I see annual dividends of $3.80/share. If the dividend is kept unchanged, our investor would recoup their investment in Johnson & Johnson using dividends alone in 31.50 years. That is a very long dividend payback.

If history taught anything, it is that companies like Johnson & Johnson regularly grow dividends. It has increased dividends for 57 years in a row, through a lot of challenging environments, making it one of the few dividend kings out there.

Let's look at two scenarios of how things can unfold. I just wanted to illustrate that an year or two of something bad happening should not mean the end of the world for a company that has the ability to survive the storm. A resilient company like Johnson & Johnson fits the bill as do a large portion of the companies on the dividend aristocrats list. While the value will be affected, it shouldn't be affected by as much as to justify a 35% decline in US stocks in one month.

Under Scenario A, everything works out, with no major issues to the dividend. If we assume annual dividend payment of $3.80/share in 2020, and annualized dividend growth of 4%/year, we could expect that annual dividends will reach $8.32/share in 2040. This is a slower than average annualized growth in dividends, which I wanted to model from a conservative base scenario. Obviously, the upside will take care of itself if growth is higher, but it is good to have low expectations in investing in order to ensure your happiness.

Anyway, if you collect all dividend payments from 2020 to 2040, you end up with $121.48/share in dividend payments. If the stock yields 4% at the time, it may also sell for a price of $208/share. If we reinvested those dividends when yields were 3% of course, we would have a net worth of roughly $390 in 2040, which is not too bad.

Under Scenario B, there is disruption, causing JNJ to stop paying dividends in 2020 and 2021. If Johnson & Johnson doesn’t pay $3.80 in annual dividend income in 2020 due to the Covid-19 epidemic causing shutdowns, everyone will panic, because the company has never eliminated dividends in its 76-year history as a public company. But, if the company survives this crisis, and resumed paying dividends in 2022, the total value of our expected dividends and share price would be impacted by this crisis today.

It would take until 2042 to recover the initial purchasing price through dividends alone, or two years longer. The value of the investment, assuming reinvesting dividends when the shares yield 3% will be $340 in 2040 and not hit $390 until 2042. So the value for 2040 is impaired by 12% - 13% from the dividend elimination for 2 years. As an investor, this means you would have to wait longer, and remain patient.

I illustrate both scenarios with the table below.



I am not stating that Johnson & Johnson will cut or eliminate dividends in 2020 and 2021. There are however a lot of great companies that are in a difficult financial position from this virus, and that position is not their fault. Noone would have expected that this virus would stop people from going out to eat in restaurants like McDonald's for example. They can easily adapt their business model to a point where they provide deliveries and order pick-ups and more drive-through ordering, but there would still be an impact to the business. Therefore, this recession will be different from others, so we may be seeing problems in otherwise stable companies. In another example, Sysco will probably face some near-term turbulence, and it may lose a portion of its clients. However, it has a strong position, and will likely survive and thrive in the rebound, even if it hurts in 2020.

The key risk is whether a company will survive this economic shutdown, without going bankrupt. A company that can survive this crisis, should protect the equity interests of its shareholders and let them participate on the rebound in economic activity after we beat the virus, and over the next few decades worth of growth as well. If the company goes bankrupts, and shareholders are wiped out, it may be owned by its former creditors, and they will benefit from its economic gains after recapitalizing the enterprise. That’s why we need to focus on survivability first.

The other risk is at the personal investor level. If unemployment is high, our investor may find themselves without a job. Some individuals have an emergency fund covering 3 – 6 months, on top of any termination benefits and state unemployment compensation. This could be a troubling time to be in, if you are out of a job, and out of other options. If you cannot find another job, but have bills to pay and no source of income, you will be forced to dip into savings.

Of course, you may have options to earn income elsewhere or cut expenses to the bone, to get you through these challenging conditions. You can always think outside the box, and pivot into something else, until the storm passes through.

I did want to discuss what I view as worst case scenarios, and how they would impact dividend portfolios. In my modeling, I project Great Depression type environments, with 25% unemployment, massive dividend cuts etc. This establishes a worst case base scenario, which lets me see that things are not as scary as they are from a financial perspective. We will rebound from this mess. I just hope we are all healthy and manage to avoid getting sick. That’s the most important thing – if we are healthy, we can always make sure that we take care of the power of compounding and continue building our dividend incomes over time.

My analysis of investing during the Great Depression showed me that the investor who patiently invested in blue chip stocks on a regular basis did come out ahead after a couple of decades of investing. You can read the article here: Everybody Ought to Be Rich

In the meantime, I believe that continuing with an investment plan is still a wise choice today. I am investing every month in a few dividends growth stocks I view as attractively valued. I share that information with readers of my dividend growth investor newsletter. I am also investing automatically in my 401 (k) plan at work. I am maxing it out, so unfortunately I cannot increase contributions at this moment.

The prices may fluctuate and go down further from here, but I know I am owning stock in some of the world's best companies.  If history is any guide, buying equity ownership in US companies has always worked in the past, and they have always recovered. It may take time, but as an investor with a 20 - 40 year time horizon, I can afford to wait this out.

This too shall pass.

The investors who will reach their dividend crossover point in 2030 will be the ones that kept investing during 2020's bear market.

Relevant Articles:

- How to define risk in dividend paying stocks?
Risk Management
Dividend Aristocrats List for 2020
Dividend Investors Should Ignore Market Fluctuations


Monday, March 23, 2020

Three REITs Delivering Fresh Dividend Growth To Shareholders

Last week was a crazy week in the US Stock market, as the number of Covid-19 cases in the country surged, and so did the number of deaths. It looks like we are in a widespread phase of panic on the financial markets, as a quarter of the US is under quarantine, with the rest to follow suit pretty soon.

It was a very slow week for dividend increases. I saw three companies with a long history of dividend increases hiking distributions last week. All three were REITs.

We have had some large profile dividend cuts and suspensions from the likes of airlines like Delta, Boeing, Ford, Marriott etc. Few of these had a track record of annual dividend increases however, so they were never on my radar. Energy companies will likely cut dividends at some point this year, however, and those have been on my radar and some of my portfolios. The expectation for US dividend payments is that they decline as much as they did in 2008, during the global financial crisis.

Stock prices are already 35%+ below their all-time-highs set just a month ago. Things are starting to get ugly, as the number of unemployed is expected to skyrocket, a lot of businesses like restaurants are closed, and a lot of businesses are losing money. We are witnessing a widespread disruption in the economy, which most probably resembles the Great Depression. The only difference is that this is happening very quickly, and strikes at a high pace.

It looks like the expectations for US earnings are to start decreasing significantly, and for GDP to fall through Q2, before attempting a recovery. It is likely that things would get ugly, before they start getting better. I am worried mostly about the millions who will get infected, and the millions who will be without jobs. And the amount of people who will die, which is the real problem we are facing.
Most probably, when we start ignoring bad news (climb the wall of worry), and stocks rally is when we will see some light at the end of the tunnel.

I do believe that the best strategy in today's environment, and in any other environment is to live within your means, save money, and invest money regularly in blue chip companies with a solid history of paying and growing dividends. If you stick to a long-term routine of regular investment, you would likely come out ahead. Even if you started investing around the time of the Great Depression.

I believe that this too shall, pass, albeit at large personal and financial loss for people in the US and the world. But just as the supply chains and economy and stock and labor markets were disrupted at a fast-accelerated pace, I believe that the recovery could be just as quick.

The pace of dividend increases has definitely slowed down from just a couple of weeks ago. Companies need bailouts, the US government is trying to find innovative ways to stimulate the economy, put money in people’s pockets, inject liquidity into the system.

There were several companies that raised dividends last week. The companies include:

Company Name
Ticker
Price
New
Old
Forward FFO/Share
Forward Payout
Years Annual Increases
10 year annualized growth
Dividend Yield
American Tower
AMT
195.39
1.08
1.01
                23.89
52.81%
9
n/a
2.21%
UDR Inc
UDR
32.03
0.36
0.34
                14.56
65.45%
10
3.41%
4.50%
Realty Income
O
47.42
0.233
0.2325
                13.55
79.89%
27
4.68%
5.90%

I think these companies offer decent value today. That doesn’t mean they cannot go down by 50% from here, as more stores shut down for example or a large portion of the population has trouble paying rent. If we think beyond the next year however, and if these companies can survive the tough season ahead, they can deliver satisfactory returns to shareholders. By the way, certain stocks are still valued richly, notably the ones like American Tower. If we see it at a price to forward FFO of 15 or lower, I would know that stock market investors are worried.

I am a fan of Realty Income (O), and believe that this high quality REIT will survive the crisis. While the dividend would be defensible under a normal crisis, I am not 100% certain for this one.



These companies are not automatic investment ideas of course. You need to do your research, and determine if they can survive this crisis first, and whether they can deliver solid returns for your long-term investment period.


Thank you for reading! Please stay safe!

Relevant Articles:

Seven Dividend Companies Rewarding Shareholders With Raises
A Record Week on Wall Street For Dividend Increases
Seven Dividend Achievers Defying Coronavirus Fears
Dividend Investors: Stay The Course


Friday, March 20, 2020

General Dynamics Corporation (GD) Dividend Stocks Analysis

General Dynamics Corporation (GD) operates as an aerospace and defense company worldwide. It operates through four business groups: Aerospace; Combat Systems; Information Systems and Technology; and Marine Systems. This dividend aristocrat has paid uninterrupted dividends on its common stock since 1979 and increased payments to common shareholders every year for 29 consecutive years. The last dividend increase occurred in March 2019, when the company hiked its quarterly dividend by 9.70% to $1.02/share

The company has managed to deliver a 6.10% annual increase in EPS since 2008. Analysts expect General Dynamics to earn $12.66 per share in 2020. In comparison General Dynamics earned $11.98/share in 2019. In today's environment, we should take earnings estimates with a huge grain of salt however, because there will be disruptions near term. I believe long-term earnings will bounce back from any temporary disruptions.


General Dynamic’s largest customer is the US Government, which accounts for 60% revenues. International defense sales account for close to a quarter of revenues, while the rest is generated from US commercial customers.

Given the constantly changing political climate, there is a high level of uncertainty behind future increases in defense spending coming out of the US. This being said, the company does have other customers in other markets and also other divisions such as the Aerospace one that is producing Gulfstream Jets. Demand in the Aerospace division will be fueled by new product introductions and demand from emerging markets.

The major risks General Dynamics include inability to win any major defense contracts, major cuts in military budgets as well as a potential for slowdown in commercial aviation. That being said, GD has managed to navigate challenging political climates in the past, with an eye on delivering superior shareholder returns.

The world is an increasingly hostile place, and the US being the world cop will surely end up spending more on defense over the next few decades. There is a strong backlog of funded contracts to the tune of 54 billion dollars. The company also has a dominant position in commercial aviation through its Gulfstream jets, which also have a backlog of orders. In addition, General Dynamics is one of the two builders of submarines and warships ( the other being Huntington Ingalls Industries). This is an example of a duopoly, where these companies are able to specialize in the manufacture of the increasingly complex ships and submarines, gain scale, and gain an entrenched position that would preclude newcomers to compete directly. It would be next to impossible for a new company to take over business from the two incumbents.

Strategic acquisitions should also boost earnings per share over time. The most recent acquisition of CSRA that just recently closed is expected to be accretive to earnings per share.

The company has been able to buyback 2.80% of its shares outstanding every year on average over the past decade. This brought the number of shares outstanding from 408 million in 2007 to 291 million by 2019.


The annual dividend payment has increased by 10.40% per year since 2008, which is higher than the growth in EPS.


This was possible, because the dividend payout ratio increased slightly over the past decade. I expect that dividend growth will be slightly higher than earnings growth over the next decade, since the payout ratio still seems low today. However, I would expect annual dividend growth of 6% - 7%/year over the next decade.

The dividend payout ratio increased from 22% in 2007 to 33% in 2019. A lower payout is always a plus, since it leaves room for consistent dividend growth, thus minimizing the impact of short-term fluctuations in earnings. Given the low payout ratio today, I believe that the dividend is safe from dividend cuts. In addition, there is room for slight expansion in the dividend payout ratio over the next decade.

Right now, the stock is attractively valued at 9.30 times forward earnings and yields a defensible 3.45%.

Relevant Articles:

How to value dividend stocks
- 2020 Dividend Aristocrats List
Thirty-One Dividend Aristocrats for Further Review
Five Dividend Stocks Rewarding Patient Shareholders With A Raise

Monday, March 16, 2020

Dividend Investors: Stay The Course

The past month has been difficult for many investors. Stocks are down by 30% from their all time highs, reached just 1 month ago. It is during times like these that you see who really is a long-term investor, and who is just a pretender. When you are a long-term buy and hold investor, you stand the best chances to take maximum advantage of the power of compounding, and end up with the probability for the highest dividend income and capital gains. These are the times where having a disciplined approach to investing pays off. These are the times when the ability to allocate capital to use in quality dividend stocks would seem stupid in the short-term, but potentially really brilliant 10 – 20 years down the road. When stock prices fall, there is an urge in the investor to protect their nest eggs from further price impairment.

This is a dangerous situation to be in because:

1) Noone knows in advance today when this correction is going to run out of steam or what its ultimate severity will be. So when you act on short-term noise, you are actually shooting yourself and those who will depend on you in the foot.

2) Therefore, if you act based on short-term price fluctuations, you are speculating and have essentially thrown out your edge of being a long-term investor. It is extremely difficult to win in investing as a short-term speculator – you will be in an out of stocks and paying taxes and commissions through the nose. Your main edge in the stock market lies in the ability to hold on to your stocks through thick and thin for decades, and cashing in those growing dividend checks ( or reinvesting them in the accumulation phase)

3) If you are in the accumulation phase, you should be praying for lower prices, because you are buying shares to provide for you in 20 – 30 years. A 200 point decline on the S&P 500 decline will likely look just like a blip on the charts 20 – 30 years from now. If you don’t believe me, check the 1987 crash. A lower entry price results in more future dividend income for you.

4) If you are in the retirement phase, you already have a plan to live off your assets. You are likely spending those dividends, and hopefully those dividends are coming from a diversified portfolio of dividend growth stocks. You are likely getting social security and possibly a pension. As long as there is some margin of safety in financial independence, and the dividend portfolio mostly consists of quality blue chips, the investor should be just cashing in their dividend checks and enjoy the fruits of their lifetime of labor.

I know that seeing unrealized capital losses hurts. However, the important thing is to just stick to your plan and stay the course. This is why I have chosen to be a dividend growth investor. When the stock market is going up, everyone is a total return investor and chases hot growth stocks and talks about how much capital gains they have made.

However, when the stock market starts going down in price, those capital gains could quickly turn into losses. Imagine having to sell chunks of your portfolio for living expenses when the stock market is going lower. You will eat your principal quickly, and increase your chances of panicking and doing the wrong thing of selling everything out. When your dividends cover your living expenses however, it is much easier to ignore those stock price fluctuations. As long as those dividends are coming from a diversified portfolio of quality blue chip stocks that are dependable, the investor has nothing to worry about. In fact, receiving cash dividends when the stock prices are going down is very reassuring, and provides the investor with positive reinforcement to just stay the course.

There is a reason why stocks have done much better than bonds in the long-run – they are riskier. With stocks, there is always the chance that there will be violent fluctuations in the price. You can have steep downturns, which can have many weak hands scrambling for the exits. When stock prices go down, many investors assume that something is wrong, they panic and sell. They forget that your upside potential in terms of dividends and capital gains is virtually unlimited. Some companies you own will ultimately cut dividends and sell at levels that were lower than what you paid for. Other companies in your portfolio will do well enough in the long term that will more than compensate for the failures you have experienced.

The issue with stocks of course is that the amount and timing of future capital gains is largely unknown in advance. This is why people panic when prices start going down – they project the recent past onto the future indefinitely. They forget that stocks are not just some pieces of paper or blips on a computer screen, but real businesses that sell real goods and services to consumers who are willing to exchange the fruits of their labor for those goods and services. Over time, those businesses as group will likely learn ways to sell more, charge more, earn more and reward their shareholders. No matter the turbulence we will experience in the US and Global stock markets and economies in the short-run, I believe that things will be better for all of us ten years from now. And as investors, we invest for the long term, not for the next 5 years or 5 months.

With bonds, you get limited upside mostly in terms of the interest payment you receive, and then hopefully a guaranteed return on investment after a set period of time. In my case, the only bonds I am interested in owning directly are Certificates of Deposit, Treasury Bonds and US Agency Bonds. This is the safety portion of my portfolio, which could ultimately account for somewhere between 10% - 15% of my portfolio by the end of the decade. The issue of course is that this portion of the portfolio will mostly keep up with inflation, at best since expected returns are low in the current interest rate environment. So while a portfolio of bank CD’s will not be quoted every day, providing an illusion that the money is safe, it is difficult to live off the small yields we see today. If inflation returns to its normal course of 3%/year, those bank CD’s will likely be unable to keep up purchasing power.

Holding on to stocks pays in the long term better than holding bonds precisely due to their “riskier” nature. If you stay the course of regularly adding money to your accounts, you will be able to buy more shares of quality companies at a discount. After the dust settles, you will be ending up with more valuable pieces of real businesses than before. It intuitively makes sense that you will be better off buying a stock like Altria  at $40/share as opposed to $75/share. If one share of Altria (MO) bought is today, and dividends are reinvested, it could result in a net worth of $400 in 30 years. This exercise assumes a total return of 8%/year, which is lower than the company's dividend yield alone. It also intuitively makes sense that if you reinvest your dividends when prices are low, you will end up with more shares and more dividend income over time.

Again, in order to benefit from all of this, you need to stay the course. This means saving money every month, putting money to work regularly, and not getting scared away. Perhaps if you are concerned about prices and you are in the accumulation phase, it may make sense to just start reinvesting dividends automatically. Or alternatively, it may make sense to automatically invest a portion of your paycheck through your 401 (k).


Relevant Articles:

Successful Dividend Investing Requires Patience
Fixed Income for dividend investors
Dividend income is more stable than capital gains
How to think like a long term dividend investor
Long Term Dividend Growth Investing

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