Friday, July 22, 2016

The paradox of saving and investing

Right now, many investors are sitting on huge unrealized gains in the companies they have bought years ago. I am in those shoes too. However, I believe that many companies are priced ahead of their fundamentals. This is why it is getting harder and harder to find quality dividend growth stocks available at attractive valuations, without having any issues to justify the low valuation.

When I was starting this blog in early 2008, there were a lot more alternatives for investing my money. At the very worst, I could simply buy Certificates of Deposit that yielded 5%, and sit on them. Equity valuations were beginning to look very appealing, and they continued being appealing through the bottom in late 2008 and early 2009. From there on, I found it easy to find quality companies selling at attractive valuations, which grew earnings and dividends for me. It was easy to run a screen, build a collection of companies that showered me with higher dividends every year, reinvest selectively and let the power of compounding do the heavy lifting for me. This was the state of my investments all the way up until early 2013.

The interesting part is that back in 2008 – 2009, I didn’t have as much money to invest, as I do today. Back in late 2007, my total net worth was slightly higher than the amount of money I can safely generate in dividends from my portfolio. I wasn’t making that much in 2009 either. Yet, valuations were very appealing at the time. For example, if I only had $15,000 to invest per year, I could have bought 750 shares of Realty Income (O) at under $20/share or 1000 shares of Altria (MO) at $15/share. The block of Realty Income would have generated $1,275 in annual dividend income, while the block of Altria shares would have generated $1,280 in annual dividend income from the get go.

Not many were able to take advantage of those once in a lifetime deals however. When the economy is poor, it is likely that employment would be much harder to obtain or retain. As we all remember, the unemployment rate was quite high between late 2008 and until its peak a few years later. The interesting thing is that if you are without a job, and you run out of unemployment benefits, you may have to liquidate your nest egg to live off if you run out of other options. For example, if your dividend income covers less than one-third of your expenses and you have no other choice, you would have to start selling stocks in order to get the cash to survive. Perhaps this is the reason why some were selling shares in 2008 – 2009, despite the fact that we had huge bargains in stocks.

When the economy is doing better however, people have more money to save and invest. Unfortunately, since early 2013, it has gotten harder and harder to put money to work intelligently. Ironically, the investing climate has gotten more challenging, when the economy and the job market was getting better and better, and a lot of people may have excess cash that could be invested.

Today, I have a lot more funds to invest. Let’s assume that I can save $60,000/year today (this is a hypothetical amount used for illustrative purposes and does not mean that this is the total amount of funds that my family can invest in an year today). With this amount of money, I can purchase less than 1000 shares of Realty Income and less than 1000 shares of Altria. So while I may consider myself a success, because in the theoretical example I could save four times as much money as 7 – 8 years ago, the reality is that the price of future income is much much higher.  In order to purchase 1000 shares of either Realty Income or Altria, I would have to shell out close to $70,000. I would expect to generate anywhere from $2,260 in annual dividend income from the shares of Altria to $2,400 in annual dividend income from the shares of Realty Income. However, I believe that these two investments to be very overvalued today. That being said, they could get even more overvalued. Those who are purchasing Altria (MO) at 22.60 times forwards earnings and an yield of 3.30% do not have a very high margin of safety.  Those who are purchasing Realty Income (O) today at 25.50 times FFO and an yield of 3.40% do not have a very good margin of safety either. Holding on to those investments, and not reinvesting dividends back may be a good call at the time. While I do not like selling, I have been personally reducing my position in Realty Income this year because the valuation at current growth rates makes no sense to me. Back when I was concerned with a possible REIT bubble in 2013, I set out some exit targets. I may be really interested in Realty Income if it drops to $48/share, which is equivalent to a 5% yield. If I get impatient however, I may even settle for a 4% starting yield, but at much reduced valuations.

All hope is not lost however. There are still attractively valued companies available for further research. Plus there are other ones that are available at attractive valuations on sell-offs, so a nimble investor may be able to pick some shares. There are third ones like Abbott (ABT) that are not on many investors radars due to the fact that financials look "messy" due to the separation in 2013. The stock is selling at less than 20 times forward earnings and yields 2.40% today.

Thank you for reading!

Are you finding good ideas for your money at current valuations? What is your opinion on Altria and Realty Income today?

Full Disclosure: Long O, MO, ABBV, ABT

Relevant Articles:

Altria Group (MO): A Smoking Hot Dividend Champion
Nine Attractively Valued Dividend Stocks to Consider
Are we in a REIT bubble?
Should I buy dividend stocks now, or accumulate cash waiting for lower prices?
Are you drowning in cash?

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