Friday, January 10, 2014

How to buy when there is blood on the streets

As dividend investors, we know that we need to purchase quality companies that sell at attractive valuations. We know that the companies to buy and hold are those that can deliver earnings and dividend growth for years to come. These dividends would meet our future expenses, and rise over time to compensate for the eroding value of the dollar. The one thing that many investors fail to take into account however, is that there are many times in the lives of a company, where it stumbles on its strategy execution. As a result, even a reliable dividend growth payer might face some uncertainty, that could make even its most loyal long-term investors lose sleep at night. These situations are usually the types of events that separate the winners from the losers in the game of long-term dividend investing.

Rather than lose sleep, the objective dividend investor should evaluate the underlying fundamentals with a cool head, and determine what to do. If the dividend cannot be increased over time, that would mean that the stock is a hold at best. However, if the dividend cannot and is not supported, this would most likely be a sell signal for a dividend growth investor. However, if there is still room for growth in earnings, that could trickle down into some dividend growth over time, then the stock is likely a buy at attractive valuations.

In previous articles I have discussed how lower entry prices usually result in higher dividend and capital returns over time for investors. That’s because purchasing a share of a dividend growth company at $40 will result in slightly faster compounding, than purchasing the same stock at $50. Unfortunately, few investors capitalize on opportunities when they are available at attractive prices. This is because in many situations, these opportunities look like the end of the dividend growth streak. For example, McDonald’s (MCD) didn't look so sexy between 2001 and 2003. The company had expanded too quickly, Americans were not very happy with the menu and the slow and rude service. Dividend growth slowed down as well, and the share price tumbled precipitously. Luckily, the company initiated a turnaround effort, remodeled stores and introduced new items, which led to pretty dramatic increase in earnings, dividends and share values. The message is to give the company you own the benefit of the doubt, and hold on for as long as possible, until you are proven wrong by the facts.

Johnson & Johnson (JNJ) was another company which faced recalls at the beginning of the decade, which spooked many dividend investors. However, the company maintained confidence in its long-term prospects, as evidenced by the increase in annual dividends. Investors who stuck with the company did have a few tumultuous years, but finally earnings per share are estimated to surpass the highs in 2010.

Right now, Target Corporation (TGT) seems to be the company that has a lot of negative publicity. The company has been unable to gain momentum in its expansion efforts in Canada. In addition, its point of sale (POS) terminals at stores have been breached, thus compromising the credit and debit cards of 40 million customers.

I see this stumble as a temporary opportunity to acquire shares of this retail giant at attractive valuations. Even if growth slows down, the company still has some room for growth in the US organically. In addition, its stores are much cleaner than rival Wal-Mart (WMT), plus it has a very loyal base of customers who love the shopping experience.

As the company is stumbling however, it is getting increasingly difficult to hold the stock. I am sure that there are thousands of investors out there who are second guessing their decision to put their money in Target. It is very difficult to have bought a stock, and then to have negative headlines about it. However, as your dividend checks clear in your brokerage account, you get some sort of a positive reinforcement that business is still getting done at Target, and the company is still earning billions of dollars every year. I do not have a crystal ball, but based on my evaluation of the situation, I plan on adding more to the stock in the coming months.

I recently added some shares of Target (TGT) commission-free using my Loyal3 account. If the shares go lower from here, I would likely add again. Unfortunately, I would only have approximately two-three opportunities to add the stock in the coming 2014. I would try to spread them out across the year accordingly. If the shares rise above $69 however, I would likely abstain from making any further purchases.

Over the past month, I have driven by several Target locations in my area, and have noticed that parking lots look full most of the time. As a result, I am fairly confident that any weakness in sales and traffic trends might be temporary, if not largely overblown.

I think the best way to take advantage of temporary weakness in stock prices is through the meticulous process of dollar cost averaging your way into attractively priced stocks every single month. A dividend investor who puts money to work every month won't buy at the bottom, but would have the discipline to put money to work, when everyone else is scared. This puts the odds of success heavily into his or her favor.

Full Disclosure: Long TGT, MCD, JNJ, WMT

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