Friday, November 20, 2015

Are you patient enough to become a successful dividend investor?

One of my largest holdings is McDonald’s (MCD). The company recently raised its quarterly dividend by 4.7% to 89 cents/share. McDonald's is a dividend champion which has raised its dividend each and every year since paying its first dividend in 1976. Given the yield of 3.20% and the dividend growth of 5% (and my estimated earnings growth of 5%/year), this sounds like a decent investment for slow and steady income and wealth accumulation. You might enjoy my latest analysis of McDonald's here.

Yet, a few months ago everyone had written McDonald’s off. Noone was supposedly eating there. Many investors sold out after earnings per share and the stock price went nowhere for 3 years. I didn’t sell however, because I know that most profits are made by patiently sitting on a holding, and doing as little as possible.

Replacing a dividend company sold is a very difficult endeavor. It requires that:

1) You correctly identify a company you own that is not going to do well, and will not provide good returns
2) You correctly identify a company that is going to do well and will return more than the company sold
3) The new company has to provide better results than the old company, and that is after accounting for taxes, commissions etc

There are several reasons below why I didn’t sell:

1) As part of my strategy, I have decided that once I purchase a company that fits my criteria, I should hold on to it no matter what, as long as the dividend is at least maintained. This includes holding on to a stock even if it misses quarterly numbers, if everyone ridicules the company's business model and its products, and if the stock price trails a benchmark by a few percentage points in a given month or year/s. If the dividend is frozen I no longer add money to the stock. I also stop adding money to a position if it no longer fits my minimum requirements for earnings per share (EPS) and dividends per share (DPS) growth, though I will keep the stock. I will allocate dividends elsewhere. If the company cuts dividends however, I will be out one second after the announcement. I am in this game to earn more dividend income every year- companies that cut dividends are not a good fit for my portfolio. This ability to stick to companies I own through thick and thin is helpful when a company I own has temporary issues that management needs to work through. If you study history, you will see that all companies enter into some sort of trouble from time to time. Bailing out any time there is some trouble will be costly, because you don’t know in advance if the trouble is short-term in nature, or whether it is the beginning of the end for the enterprises earnings and dividends power. Thus, I am lenient up to the point where dividends are cut. Before that I start minimizing losses by allocating dividends elsewhere, and not adding more new funds to a position. Managing risk of loss in future income is as important as selecting the best dividend stocks of the future.

2) When I analyzed my stock sales. I noticed that selling to buy something else is usually a big mistake. I have learned from this experience that more often the best thing to do is to sit tight. Usually, by the time everyone gets impatient, this is a good time to buy, not to sell. For example, McDonald’s had some troubles in the early 2000s, when earnings didn’t grow and dividend growth was anemic at 5%/year. Those who sold missed an opportunity. Those who held on enjoyed annual dividend growth of roughly 22.80%/year.

I can afford to be patient. I let management do its job. I give them leeway, and don’t micromanage them. I realize not everything will go smoothly, which is why patience is important. I also realize that I have entrusted my money in management’s hands during the buy process of a long-term investment. If I evaluate them every quarter and micromanage them I am not really being a long-term investor. If I lack the patience and run away at the first time of trouble, I will never become a good long-term investor.

I try to minimize the number of items that could make me impatient. I don’t compare to say S&P500. If i believe in the long-term prospects of a business, it makes absolutely no sense that stock price did a little less than broad index. As long as the dividend is paid and grows, I provide some leeway to management. If they cut the dividend however, I am gone one second after the announcement. This is a rule I follow. Some may argue about semantics, telling you that a dividend cut is usually a sign of a bottom in cyclical industries. That’s great, but the problem is that cyclical industries do not have long track records of dividend growth. Big oil companies like Exxon Mobil (XOM) and Chevron (CVX) are more of an exception rather than the rule.

People who get impatient and sell, usually end up selling something that is low, to buy something that is high. I have made the same mistake. I sold Con Edison (ED) to buy ONEOK Partners and then sold the units in ONEOK Partners (OKS) to buy ONEOK Inc (OKE). I was blinded by slow growth in Con Edison and chased both high yield and high distribution growth of ONEOK Partners and later ONEOK Inc. Given the high dividend yield today in ONEOK, there is a higher risk of a dividend cut.

3) While I saw that earnings are not going anywhere, which could limit dividend growth, I also saw that there is room for improvement. I believe that even if revenues and net income do not grow, the company could be able to pay a 3.50% dividend and just grow earnings per share by 4% – 5%/year by doing stock buybacks alone. If the business picked up, then this could translate into better opportunities for the company’s patient investors. In the meantime, any dividends I received acted like an instant rebate on my purchase price. I was getting paid to hold the company, while management was working on turning the company operations around. The 3.50% yield could have been obtained by anyone who bought McDonald's stock prior to September 2015.

Overall, the jury is still out if management can turn things around at McDonald’s. In my book this means finally growing earnings per share, which should fuel future dividend growth and growth in the intrinsic value of each share I own. However, I will patiently hold on to my position, and use the dividends to buy other dividend paying stocks. I firmly believe that time in the market is more important than timing the market. It is impossible for the average person to forecast whether a short-term problem turns into something big or not. This is why I patiently wait for companies to turn around, and to compound my income and capital for the long-term. Only if I am proven wrong by a factual dividend cut do I decide to make an active decision.

What is your opinion on McDonald’s? Do you consider yourself to be a patient investor?

Thank you for reading.

Full Disclosure: Long MCD, OKE, CVX, XOM

Relevant Articles:

The most important metric for dividend investing
McDonald's (MCD) Dividend Stock Analysis 2015
Successful Dividend Investing Requires Patience
Three Commission Free Investments and a Dividend Increase
Time in the market is your greatest ally in investing

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