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

28 comments:

  1. Thanks for the article... very informative and helpful.
    However, regarding 'pruning bad apples', you said... "If the company cuts dividends however, I will be out one second after the announcement."...
    Isn't that 'one second' usually too late... history shows potential 20-50% sell-offs when these dividend cuts/eliminations occur?... And doesn't this usually 'kill' alot of the gains that you've made?
    Thanks

    ReplyDelete
  2. That was inspiring in a nose to the grindstone kind of way. I like McDonalds but never pulled the trigger. Boo on me.

    ReplyDelete
    Replies
    1. I have found that buy and hold works, as long as I let those holdings on their own for years.

      Delete
  3. Ross Stores (ROST) dropped over 10% last week when Macy's reported lower earnings. Today ROST reported very good quarterly numbers and the stock price has reversed its weekly loss. This is why I am a DGI follower and dividend investor. ROST boasts an annual dividend growth rate over 20% for the past 20 years (hat tip to Robert Allan Schwartz great web site). That is my focus and not the weekly gyrations of feckless stock price swings. Jungle Jim - long MCD and ROST.

    ReplyDelete
    Replies
    1. Yes, ignore the market price. However, it is good to review the business at least once every 12 - 18 months

      Delete
  4. Patience is the key! Sure learned to be more since I'm a DGI. ;-)

    Mike

    ReplyDelete
    Replies
    1. Yep, and you should read this one too: http://www.dividendgrowthinvestor.com/2015/11/time-in-market-is-your-greatest-ally-in.html

      Delete
  5. Very nice article, thank you I enjoyed learning about your strategy on managing your holdings. I have a hypothetical question if you care to play along.

    Lets say that you are gifted shares in stocks that you wouldn't otherwise buy, for example, QCOM, F, GM, BAC, PXD, YELP.

    Not really consistent dividend growth stocks that fit your strategy but now you are the new proud owner. Cut and run and move on to the usual DGI names or do the principles in your article still apply and just hang on?

    Thank you I appreciate it.

    ReplyDelete
    Replies
    1. The core ideas behind those articles could apply:

      http://www.dividendgrowthinvestor.com/2015/01/how-to-invest-lump-sum.html

      http://www.dividendgrowthinvestor.com/2015/02/how-to-convert-portfolio-of-index-funds.html

      I am not sure what you should do in the situation - it would depend on the specifics, which are not the same as a simulation. Plus I cannot provide individual investment advise

      Delete
  6. DGI,
    Being retired, I have limited new capital to invest and must resort to selling old positions to start new ones. I sold MCD this summer and used the proceeds to buy twice as many shares of WFC since we had zero investments in the financial sector. MCD is up about 15% since then, but WFC is up 8%, so it hasn't been a catastrophe. It does, however, give another data point supporting your position that selling one stock to buy another generally ends up being a bad move. You live and learn even at 58.

    Dividend cuts resulting in an automatic sale might not always be the best policy, but you are so successful that I am not suggesting and wouldn't expect you to change your rules. We hold shares of GE and PFE, both companies cut dividends in 2009, and in GE's case it was because they did not do a good job of managing their financial division. PFE cut dividends in half (from $0.32 to $0.16 per share) to buy Wyeth and the dividend still hasn't fully recovered (currently at $0.28). The share price, on the other hand, has doubled since then and this has been a good investment overall. Tim McAleenan Jr. had this to say this morning regarding GE's cut:

    "People still begrudge General Electric CEO Jeffrey Immelt for promising to maintain the GE dividend before it was cut. Many sold their shares in anger upon the dividend cut. The problem? This disgust acted as a low point for the stock, and General Electric has returned 17.8% annually since its dividend cut."

    Looks like I'm making an argument to keep stocks after the dividend is cut, but that is not what I am advocating. I am suggesting that selling after a cut probably is the better decision most of the time, but that the individual circumstances should be considered. In the case of PFE and GE, I would have kept PFE but sold GE (I bought them in 2013). I don't think we could have predicted the high returns for GE, but PFE's decision to use the capital to grow the business was solid IMO.

    I have been making portfolio changes this fall, taking advantage of market volatility, and trying to increase the strength of the portfolio while maximizing yield (and those 2 goals tend to go in opposite directions). MCD falls in the sweet spot for dividends from blue chip stocks, and I should have kept the shares. DGI 1, KeithX 0 :)
    Thanks,
    KeithX

    ReplyDelete
    Replies
    1. Coincidentally, I read Tim's article you referred to just before this one, and neither one is more right than the other. I happened to buy a chunk of GE just after their dividend cut; it seemed to me there was no way they'd be going out of business, as the market implied, and yes, they've done well since. The question of including cyclical companies/industries in an income-producing portfolio has no right answers, and overall it comes down to strategy, assets, and patience. I can see why DGI would not want to own Billiton, and I can also see why Tim would. Each investor must decide what makes sense for him/her in the grand scheme of things and a future fraught with risks and opportunities.

      Delete
    2. Hi Keith,

      I have written extensively on dividend cuts, GE, the financial crisis, companies that cut and then raise dividends. It is easy to say after the fact that investing in GE in 2009 would have been a no-brainer. The problem is that everyone who says they bought in 2009 didn't tell me at the time. So either everyone is suffering from survivorship bias, or they are just much better at investing than me.

      On the other hand GE raised dividends between 2010 - 2015. Now it has stopped growing them again ( in favor of buybacks)


      http://www.dividendgrowthinvestor.com/2014/05/dividend-investing-during-financial.html

      http://www.dividendgrowthinvestor.com/2014/01/should-income-investors-give-general.html

      http://www.dividendgrowthinvestor.com/2015/09/survivorship-bias-in-dividend-investing.html

      http://www.dividendgrowthinvestor.com/2015/08/do-not-get-emotionally-attached-to.html

      http://www.dividendgrowthinvestor.com/2009/06/replacing-dividend-stocks-sold.html

      http://www.dividendgrowthinvestor.com/2008/09/which-bank-will-be-next-follow-dividend.html

      http://www.dividendgrowthinvestor.com/2009/01/dividend-cuts-worst-nightmare-for.html

      http://www.dividendgrowthinvestor.com/2011/03/avoid-dividend-cutters-at-all-costs.html

      Delete
    3. Hi Even Keel,

      Investing is part art, part science. The goal is not to be right or wrong, but to make money.

      I personally don't follow Tim Mcalleenan, because I do not know how he actually invests his money. You might be the best stock analyst in the world, but if you never put real money behind your conviction picks, your efforts had been fruitless.

      For example, I want to know why did he sell COP and IBM?

      I also want to know why he keeps talking so positively about AT&T but doesn't own any?

      This is one reason why Jason Fieber was so popular with many - he provided an image of transparency.

      Delete
  7. Great point, I've learned a long time ago that being patient is more important than going in and out of the market. Unless you're a day trader (which you shouldn't be in the first place), you're better off holding whatever you decide to buy more than 5 years.

    ReplyDelete
    Replies
    1. Hi Tawcan,

      The more I research things, the more I realize that just buying and holding is the thing to do. I know that almost noone can consistently buy low and then sell high, switching in and out of stocks.

      Best Regards,

      DGI

      Delete
  8. Another great article. I'm with you - been holding and recommending MCD through it's weakness. The company was/is still strong, it was just going through a difficult period.

    ReplyDelete
  9. I wanted to thank you for your MCD advice.

    When MCD was down and all the "gloom and doomsayers" we're trashing it, I sent you a note asking if you thought I should sell MCD. You suggested holding and I went with your excellent advice.

    Thanks for giving us your perspective on having patience as investors.

    ReplyDelete
    Replies
    1. Well, MCD is not out of the doldrums yet, but things are not as terrible either. Let's see if they can turn around their operations ( or at least stay clear of eColi like CMG)

      Delete
  10. Hi DGI:
    I am curious why you have absolute zero patience with dividend cut? unlike earning fluctuation, you do not believe dividend cut can be temporary, thus does not deserve our patience to wait for it to come back up?

    ReplyDelete
    Replies
    1. Hi Cecilia,

      Actually I believe the article answered this question. Please check it again and also check the links to other material.

      DGI

      Delete
  11. I like MCD a lot, but lately the price is starting to worry me. I kept buying again and again when the price dipped below $90, thinking that there would be some resistance at $103. It finally went past that resistance and I am extremely tempted to sell. It has made money for me in spades, especially with such a short timeframe. I guess we'll just have to see. I might keep it for the dividend alone.

    ReplyDelete
    Replies
    1. It seems like you are a short-term trader, who looks at stock prices rather than fundamentals. This is not my cup of tea. Never the less I wish you good luck!

      Delete
  12. I like the idea that making 3 right decisions in a row, buy a stock at low > sell the stock at high > reinvest the money for a stock at low price, is a challenge compared to making 1 right decision: buy. Hence, make home work, buy quality company and hold. DGI makes sense here.

    ReplyDelete
  13. I sold McDonald's a few months ago, primarily because I wanted to allocate funds elsewhere. The decision has taught me to be more patient. I'm still in the early stages of building my dividend portfolio - at a little over $1,000 annually. I'm finding that your blog validates many of the principles I've been feeling out in the process. A patient approach to accumulating quality companies is the key.

    ReplyDelete
  14. Thanks for another great post DGI.

    I bought some MCD shares when it dipped early last year. Even with all the negative press, it is still a very profitable company. I don't worry about the short term results, the business fix the problems and take care of itself. Stock price movements are irrelevant as long as they keep paying and increasing their dividend year after year.

    Take care!

    ReplyDelete
  15. DGI,

    Thanks for the great article! I have one question, though. You said that one major factor in deciding to let go of a company is if they cut their dividends. I completely understand that rationale considering your goals as an investor, but do you have other factors that might cause you to drop a position? There is often a lot of talk about picking stocks, but not much is said about deciding when to let a company go. Thanks for your advice!

    Jim

    ReplyDelete
  16. Hi DGI,
    You mention "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.” Can you point me to some of your post that discuss this further?

    Thanks

    ReplyDelete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

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