Month: March 2021

Selling Dividend Growth Stocks

Posted by BM on March 21, 2021

Trees don’t grow to the sky or do they? In my USD portfolio in 2019 last year I sold 1/3 of my position in Microsoft and Visa and more recently in Apple because all three looked to be overvalued. My logic was that the stocks would ‘correct’, and I would be able to buy back in at a lower price. This got me thinking about what a dividend growth investor should do when stocks in their portfolio’s appear overvalued.

In my annual update from 2019 I wrote about my criteria for selling:

“When we make an investment, we take a patient, long term investment horizon and expect to hold the stock for decades, keeping portfolio turnover low. Generally speaking, we will only sell a stock if the safety of the dividend payment has come into question, the company’s long-term earnings power appears to have become impaired, the stock’s valuation reaches seemingly excessive levels, or we find a more attractive idea.”

With the three stocks listed above I chose to sell based on what my process told me was ‘historic’ over valuation. Interpreting the graphs: The ‘black’ line is price; the ‘blue’ line is P/E and the ‘orange’ line is a historical fair valuation metric of 15 P/E.

Apple is trading at a P/E that is 107% higher than its ten-year average.

Microsoft is trading at a P/E that is 80% higher than its ten-year average.

and Visa is trading at a P/E that is 50% higher than its ten-year average.

Warren Buffet probably would have disagreed with my decision to sell.

“Truly good businesses are exceptionally hard to find. Selling any you are lucky enough to own makes no sense at all.” Warren Buffet Annual Letter 2018

I understand with what Buffet is saying about how hard it is to find good businesses. I believe that all three are wonderful companies that are set up for continued growth going forward, but I felt it was time to take advantage of the capital gains being offered to me, and to do some de-risking in my portfolio. Sorry Warren!

Although I left a little money on the table in 2020 by selling some too early, I was still able to participate in the success of these wonderful companies by retaining 2/3 of my original positions in all three stocks. I will most likely trim again as valuations continue to make me uncomfortable and undervalued opportunities in other stocks I follow are revealed.

When to sell is a personal choice for dividend growth investors and one you should take seriously especially if the dividend is still growing. As it turns out I was fortunate to be able to quickly deploy this extra cash generated when COVID hit and was able to reinvest in sensibly priced companies. This has already turned out to be a prudent choice regardless of how these three companies perform going forward.

Trimming your positions due to overvaluations is a good problem to have but, better yet, is redeploying that capital in quality, sensibly priced, DGI stocks that can increase your current income and provide a margin of safety to your portfolio moving forward.

“A company’s valuation level, at time of purchase, significantly influences subsequent returns. As, “risk is more often in the price you pay than in the stock itself”. C.Browne’s Little Book of Value Investing.

Double-Double Club

Posted by BM on March 14, 2021

The “double-double” is a uniquely Canadian term that most of us attribute to Tim Hortons. It will get you a coffee with two creams and two sugars (or double cream, double sugar). If it were up to us, we would also add the term “double-double” to the growing list of all the things we have found magical about dividend growth investing (DGI).

When we started the Magic Pants Wealth-Builder (CDN) dividend growth portfolio eight years ago, we knew we would be provided with stable growing income in the years ahead, but it was difficult to imagine the total returns we would end up receiving on some of our initial DGI picks. We had no idea at the time what the price today would be for the DGI stocks we purchased then. Our research at the time told us that if past performance was any indication, we could expect our portfolio income to double in ten years and that was fine with us.

What we had not discovered back in 2012 and something that makes dividend growth investing truly magical, was that the price of a stock also tends to rise as the dividend grows. Price and income for both Franco Nevada (FNV) and Magna (MG) have already doubled with Magna’s price doubling for a second time.

Think how comforting it is to know that as an investor you only need to track one metric to measure your short-term performance; How much did my income rise last year! Price growth and total return will come, you just have to be patient.

The chart below shows the dividend and price growth of the stocks we purchased in 2012 and 2013 when we was just starting out with dividend growth investing. The highlighted ones (FNV, MG) have recently joined our ‘double-double’ club.

Having your stocks join the ‘double-double’ club in less than ten years is certainly exciting but how do you know which stocks are more probable to achieve this status than others?

Selecting quality companies with at least 10+ years of consecutive dividend growth is always a good place to start. Next, we look for historical dividend growth rates in the 6-8% range, or if the yield is lower, a bit higher. From there we let the magic of compounding take effect. If we can find stocks with a history of increasing their dividends more than 7.2% annually (Rule of 72) then we are well on our way to doubling our income over the next ten years. Not all our stocks will double both their income and price over the ensuing ten years, but a well-constructed portfolio selected primarily on dividend growth is more likely than not to achieve this goal.

2020 in Review

Posted by BM on March 7, 2021

The year 2020 was certainly one for the history books. On the investing side of things there was lots to remember and learn from as well. The stock market crash of 2020 began on Monday, March 9, with history’s largest point plunge on the US stock market up to that date. It was followed by two more record-setting point drops on March 12 and March 16. The stock market crash included the three worst point drops in U.S. history. If you had retirement savings or other funds invested in the stock market, the crash lowered the value of your holdings. When something like this happens, many people panic and sell their stocks to avoid losing more. But the risk with that strategy is that it is difficult to know when to re-enter the market and buy again. I was incredibly happy to have a solid investing strategy in place that continued to pay dividend income throughout the market turbulence and gave me the confidence to make the right investing decisions. By the end of the year the USA S&P 500 was up 18.4% and the CDN TSX was up 5.6% which on average, allowed patient investors to ride out 2020 virtually unscathed with a good return on their invested capital.

I am a firm believer in having a rules-based process for everything you do in life, but March 2020 was the first time my dividend growth process was truly tested. On top of that, I joined the category of ‘retiree’ about midway through the year which meant that all my investment decisions going forward would directly affect the capital I had set aside for retirement. I felt a heightened sense of pressure to make the right choices. Thankfully, I had a process I have been fine tuning for the last eight years.

Dividend growth investing is simple to understand with only three basic rules:

Quality; only buy companies that have a long dividend growth streak and good financial safety metrics in an industry that is stable and growing.
Valuation; look to buy a company that is fairly or undervalued.
Monitor; keep an eye on your dividend growers; especially the current yield; fluctuations in yields send signals. The consistency of a firm’s dividend growth is the best measure of management’s confidence in the long-term growth outlook for a company.

I already knew which companies were ‘Quality’ businesses with good financial metrics and stability. I have been researching dividend growth companies for years and my ‘List’ is always ready to go. Rather than initiating new positions at the low point in the market I chose to stay with companies I already held and knew well.

Valuation was next. I looked at how the companies on my list had historically been valued using three valuation metrics. Historical dividend yields (Dividend Yield Theory), Graham Value and Cyclically Adjusted Price to Earnings ratios (CAPE) made famous by Robert Shiller.

As the market spiralled downward in March, I topped up positions in a couple of Canadian Banks (RY, TD), a Consumer Goods stock, Magna (MG) and an out of favour Energy company (SU). In my USD portfolio I bought an Industrial stock (UPS). I really did not pay much attention to the industry or sector these stocks were in, I simply followed my process.

The most difficult thing to do was to buy more when my original purchase dropped 10% or more shortly thereafter. As you will see from the chart below, buying quality companies that are undervalued is a terrific way to super charge your long-term investment returns.

Here are the results as of March 12, 2021 on those March 2020 COVID purchases:

A one-year price/capital return, on average, of 54%!

Buying opportunities like March 2020 do not happen every year but you should be prepared and confident to pull the trigger when they do. Having a good process does that for you.

My process also tells me not to SELL my good dividend growers unless:

The company’s long-term earnings power appears to have become impaired.
The stocks valuation reaches seemingly excessive levels.
Or, I find a more attractive idea.

I did SELL some of my dividend growers in 2020 for one or more of the reasons listed above but not because I panicked when their price came under pressure due to the pandemic. As a new investor to DGI I have made a few mistakes and most of my SELLs are due to mistakes I made early on.

Finally, I will continue to monitor all positions as part of my process. Case in point is the 2020 dividend reduction of my Suncor (SU) position. I like its recent Q4 earnings and price growth but am still debating if I want a cyclical stock like Suncor in my retirement portfolio. With the recent uptick in oil prices, my guess is that the dividend will be raised back up to pre-pandemic levels in 2021/22 and my decision will be even more difficult. A nice decision to have.

As the Dividend Grows so does the Price

Posted by BM on March 5, 2021

“As a company’s cash flow (earnings, dividends) increases the firm becomes more valuable, intrinsic value rises (retained earnings) and thus the company’s stock price goes up.”

-Tom Connolly

It was only over the last few years that I noticed my dividend and price growth correlating very closely on my personal portfolios. I had always looked at historical growth rates to screen for candidates to add to my portfolios but to see it happening on portfolios I had built on my own was a welcome discovery.

The link below is an excellent article on the topic of ‘rising income drives rising prices concept’.

https://northstarinvest.com/the-importance-of-dividend-growth/

“We know from research on the stock market in general and from research we have conducted on dividend growth stocks that there is a high correlation between the growth of the dividend and the growth of a stock’s price. * Our research indicates that over 10 to 12 year cycles, the correlation between dividend growth and the stock price appreciation has been approximately 80% and over 25-year cycles it’s close to 90%.

That essentially means as the dividend grows, the price grows at roughly a similar pace over the long term. That’s why we focus so much on the dividend growth. If we do that right, we are highly likely to see the stock’s price appreciate as well. This is where the control aspect of the portfolio comes into play. Many investors feel as if the stock market is a mysterious beast and that they are simply subject to the whims of market returns. But if you link the value of your stocks to the income produced and focus on building that income, you are also highly likely to see the price appreciate as well.”

*Ned Davis Research

Here are the 10YR Compound Annual Returns of ‘The List’. 10YR_CAGR-The List-01-01-2021

Notice the 10YR Averages of the compound annual dividend growth rate (CAGR 10Y DG) and compound annual price growth (CAGR 10Y PG) of ‘The List’ in this spreadsheet. The evidence is hard to refute…as the dividend grows, the price grows at about the same rate.

Getting the dividend growth right tilts the deck in our favour and increases the probability of an above average total return (CAGR 10Y TR).

Our Dividend Growth Investing Process

Posted by BM on March 1, 2021

Our goal as dividend growth investors is clear, “‘we buy quality individual dividend growth stocks when they are sensibly-priced and hold for the growing income (cash flow).”

The process we use is a ‘rules based’ process. It is a repeatable process in all markets that tilts the odds of making a quality investment decision in our favour.

I like this quote from Annie Duke in her book ‘How to Decide-Simple Tools for Making Better Decisions’. Why does your process matter more than anything else?

“Because there are only two things that determine how your life turns out: luck and the quality of your decisions. You have control over only one of those two things.”

A quick story to demonstrate why a good process is so important.

Being Lucky vs Being Good– Vishal Khandelwal

Let’s say you sponsor a contest to determine the “world’s best coin flippers.” About 100,000 people from across the world come together to participate in this contest. Everyone flips a coin at the same time.

After each coin flip, those who flip “tails” must leave, until the only people left have flipped 10 consecutive heads. Basic statistics suggests that we could expect about 98 coin flippers to remain at the end of the contest.

The odds of flipping heads 10 times in a row are 1/2^10 = 1/1024. So, for 100,000 participants, there will be 100,000/1,024 = 98 people who would have flipped 10 consecutive heads.

Then, these 98 “skilled” coin flippers would get thousands of likes on Facebook, and followers on Twitter. Those with the best smile and social media skills will write bestselling books about coin flipping, sharing their secrets of how to become a world-class coin flipper.

Sadly, most of us most of the times judge the quality of our decisions and actions by one single factor, and that is our one-off good performance that comes easy and at the very beginning of our endeavour.

Investing is not any different. As investors, we often struggle with judging whether a decision was good or not, even in hindsight, because like the winning coin flippers we often only look at the outcome and not the process. The truth, however, is that a good process is the only thing that could help you bring the odds of success in your favour. It’s only with a good process that you stand a chance to do well in investing over the long run.

As dividend growth investors we do things differently. That is how we win!

“I do believe it is possible for a minority of investors to get significantly better results than average. Two conditions are necessary for that. One is that they must follow some sound principles of selection that are related to the value of securities and not to their market price. The other is that their method of operation must be basically different from that of the majority of security buyers. They have to cut themselves off from the general public and put themselves into a different category.”

Ben Graham

By standing on the shoulders of giants, those great investors who came before us, we have come up with a process that is simple to understand with only three basic rules:

Quality; only buy large-cap companies that have a long dividend growth streak and good financial safety metrics in an industry that is stable and growing.
Valuation; look to buy a company that is sensibly priced or undervalued by looking at a company’s track record. Undervaluation introduces a margin of safety. You are in essence tilting the odds in your favor that future price movements will be upwards.
Monitor; keep an eye on your dividend growers; especially the current yield; fluctuations in yields send signals. The consistency of a firm’s dividend growth is the best measure of management’s confidence in the long-term growth outlook for a company.

Our dividend growth magic formula is: Quality + Value + Yield + Growth = Long Term Success

The blog will help those interested in dividend growth investing to better understand how it works and how to use it on their own with a little coaching.

We will also review our outcomes regardless of if they were good or bad. Having a good process means you go back and review your decisions when they fall outside your expectations. We can then make tweaks based on our findings and enhance our process. Only then will we know if we were good or just lucky.