Friday, April 23, 2021

How To Handle Declines In Share Prices

When stocks are volatile or start falling sharply. I start receiving an above average level of inquiries from readers, asking if now is the time to consider buying.

These questions are rational and logical. After all, a drop in stock prices definitely creates more opportunities to identify quality companies at a lower valuation. When you buy at lower prices, you lock in higher dividend yields from the start, and you can generate higher returns potentially than if you bought at higher prices. It is important to make sure that the dividends are secure of course, and there is sufficient earnings power behind them to cover the distribution.

It is possible that acting right away may be a wise move, if stocks rebound like they did after the December 2018 and March 2020 lows. However, you never know if stock prices may not go even lower from here, confusing everyone else who has been conditioned to just buy the dip over the past decade. It is always good to have a shopping list ready at all times however.

I believe that slowly adding on the way down may work ok. I usually do some buying every month because I invest when I have money to invest. I believe that regular investment each month in the best values I can find at the time beats sitting in cash, waiting for a crash. Time in the market beats timing the market.

I believe that investing regularly in companies available at nice entry valuations when you have the money is the best thing to do. It allows me to receive dividends earlier, and to get the longest possible compounding of earnings and dividends. I do not believe that in the grand scheme of things it would matter 20 - 30 years from now if I bought for example Altria (MO) at $45 or $55/share. If Altria ends up generating $200 in wealth per share over the next 20 years, the difference will not be much in entry price. If Altria goes to zero, it wont matter either if I bought at $45 or $55/share. Given forward earnings of $4.58 for 2021 and annual dividends of $3.44/share, I believe that the stock offers a good value at either price point. It has managed to grow earnings and dividends per share at a steady rate, albeit it has made some ill-timed acquisitions that I disagree with. But some good businesses can withstand some managerial missteps too, as they are resilient. 

That being said, this is also not an excuse to just buy at any valuation. I do look at P/E ratios, in conjunction with dividend yields, dividend and earnings growth, and bond yields in order to come up with a rough estimate of whether a stock is cheap or expensive. I cannot put it into a formula however. I do believe valuation is more art than science. You can read more about my valuation techniques here, though you should know that I also have evolved and have raised my P/E ratio requirement higher.

So while I doubt it would matter in the next 20 years whether I bought Altria at $45 or $55/share, it may matter if the P/E multiple is at 40, given the growth rate today. That means that I won't pay $180/share for Altria today. There are companies like Brown-Forman (BF.B) today that sell at that range. It does matter if I paid 40 times forward earnings for Brown-Forman today or 20 times earnings for Brown-Forman (BF-B) today. Given the forward earnings of $1.70/share for 2021 and annual dividends of 72 cents/share, I cannot make myself pay even $51/share today for this asset. There are other quality companies with similar growth trajectories and stability of earnings streams today, available at cheaper prices.

At the end of the day, what really matters is selecting companies that can grow earnings and dividends over time, which results in compounded returns on capital. In a previous article I compared  the impact of a regular investment in Johnson & Johnson (JNJ) at its lows to an investment in Johnson & Johnson at regular intervals. I found that the latter approach delivered returns which were not too bad relative to the perfect approach of buying into every bottom. As we know, no one can consistently buy at the bottom. However, we can all develop a strategy that we can follow with a level of consistency ( example being allocating money every month or so, through thick or thin). In retrospect, Johnson & Johnson was quite often attractively valued at that time as well.

Luckily, in the past 13 - 14 years that I have shared my thoughts on Dividend Growth Investing, I have always found at least 10 - 15 attractively valued companies to invest in every single month. This makes it easy to deploy funds in the best values I find at the moment no matter whether we are in a bull or bear market. It helps me to invest consistently, and focus on time in the market, not timing the market.

I believe that the ability to buy shares regularly at a good valuation is more important than getting the best price. Waiting for the best price may turn into market timing, which can lead to behavior errors. By keeping it simple and investing every month on a regular schedule, I will be able to build my portfolio through the ups and downs of investor sentiment, and I will be able to build out a diversified portfolio by taking advantage of stocks and sectors when they are temporarily out of favor. I have the power of compounding working for me for the longest period of time by investing regularly.




2 comments:

  1. Totally agree with your points. A long-term view makes today's moves irrelevant. One only has to look at historical market corrections to see how minute they appear over the long run.

    As an aside, I find that div growth investing keeps me from making irrational decisions when prices don't go my way. The regular stream of income is like a consistent reward for holding. It's a great behavioural modification tool.

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  2. Great post and great points.

    If executed well, price fluctuations on dividend stocks shouldn't matter. What I want from my stocks is steady cash flow. I am a late comer to dividend investing. I'd rather run a boring bond ladder where bond price fluctuations don't matter as long as you hold to maturity. However, my bond ladder stopped working when I could no longer replace the top of my ladder with reasonable inflation-adjusted yields (thanks, Fed).

    I have been able to find high quality dividend stocks with good yields and I plan to hold those forever or until they trigger a sell by cutting their dividend. Stocks are riskier than bonds, lower on the capital structure, but I am comfortable with that risk. We'll see how I do when tested by a real bear market.

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