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Discussion: 3 Paths

There are three paths I follow with dividend stocks.  Reinvesting, collecting, and trading.  I have strict guidelines for each.  I never ignore those guidelines.  And, I have three separate accounts for these paths so that I can easily and accurately judge the progress of each.

Because I’m in my late 50s I have a minimum of a 3% dividend yield for those stocks I choose to invest in for the reinvesting track.  The simple reason is I don’t have many years until retirement so I feel like I need to start with a higher dividend yield to compensate for the lack of years going forward.  If you’re considerably younger and have time on your side, there’s no reason to set such a high hurdle for the starting yield unless that’s just your preference.  I concentrate on those stocks that meet my 3% minimum and that are either at a low monthly close for the last year or more and are less than 30% above the 60 month (5 year) moving average, or meet the 3% minimum and are below the 60 month moving average.  I plan to hold these stocks forever.

For the collecting track, I invest in those stocks that have at least a 1% dividend yield, are less than 30% above the 60 month moving average, and are at a low monthly close for the last year or more.  In this path I’ll hold a stock and collect the dividends until the stock price doubles at which point I’ll sell half of the position to reclaim the original investment and then hold the remaining half as a permanent value holding.  This can be used as a gradual method to create an emergency fund if you collect the dividends and don’t reuse them for investing.  This path allows me to invest in attractive companies that don’t meet the 3% minimum of the reinvesting path.

I allocate a small portion of my capital to the occasional purchase of a dividend stock that has had a significant correction from it’s 5 year high close and look to sell for a small profit (15% or more) based on a monthly target scale that increase over time.  These opportunities are fairly infrequent, and my goal is to sell these stocks within no more than 1 year.  It’s very much a hit-and-run strategy.  I only employ a small percentage of my capital per each trade, and I don’t use stops.  Going in I’m prepared to hold these trades for as long as it takes to meet the target which has a maximum of 50%, even if takes years.  I choose to view each trade in this path individually and not collectively as an averaging process.  The basic idea for this path is to continue to reinvest the profits in the next trade as a means of compounding gains over and over again.  My ultimate goal here is to create multiple “income” streams so that one or more are ongoing at all times.

I strictly adhere to “the #1 rule is don’t lose money” and “the #2 rule is never forget rule #1” mantra for all my investment paths.  And, for most people I recommend the reinvesting and collecting paths over the trading path.  They are the most forgiving, the easiest to manage, and make the best use of the “time is on our side” function of investing.

But, I find when discussing investing with people they almost always gravitate to the trading path.  And I get it.  It’s more exciting.  But because trading relies totally on random short term price movements, it’s also very much like gambling.  While my trading path is based on very high probability setups, there is absolutely no guarantee that each setup will perform in a timely manner.  The market does what the market does, especially in the short term.  So you absolutely have to understand that, acknowledge that, and prepared for that when trading.  In other words, when trading I expect the worst and accept what happens when it happens.   You can’t control the market so it’s useless to get upset if it doesn’t do exactly what you thought it would.  You just have to accept what it gives you and move on.  Only using dividend stocks in trading is my way of hedging against an uncertain outcome because if I’m forced to hang on to a trade for many months, even years, I’m collecting dividends while I do.

If I were forced to choose only one path, it would be the reinvesting track.  It is an autopilot process.  It makes the best use of time.  And, it’s self-correcting in many ways.  It is without a doubt the best way to create a substantial dividend stream over time, which is my primary purpose for this entire process.

Discussion: Effect of reinvesting over 10 years or more

The examples of reinvesting found below are based on a monthly $500 investment in companies that have:

  • Paid dividends for at least 5 years
  • Have either raised their dividends for 5 consecutive years or have a positive growth rate for the past 7 years
  • Are less than 30% above the 5 year monthly moving average
  • Have a dividend yield of 3% or more (4% for utilities and REITs).

All dividends collected were reinvested in the issuing company through December 2016.  No outside funds were invested after 2006 so that reinvesting accounted for all shares accumulated after December 2006.

The Excel worksheet below contains 30 examples illustrating the power of reinvesting.

Reinvesting Examples

Worksheet Abbreviations

  • DFI indicates date of first investment.
  • TFI indicates total funds invested.
  • RYDC indicates total dividends collected in 2016 when reinvesting.
  • YDC indicates total dividends collected in 2016 without reinvesting.
  • RDY indicates associated dividend yield of 2016 dividends to funds invested when reinvesting.
  • DY indicates associated dividend yield of 2016 dividends to funds invested without reinvesting.
  • RSV indicates the total value of all shares held at the end of 2016 when reinvesting.
  • TRET indicates the total return including all dividends collected without reinvesting.
  • %RP/L indicates the percentage gain when reinvesting.
  • %P/L indicates the percentage gain without reinvesting.
  • APR indicates annualized percentage rate of profit growth when reinvesting.

Notes and discussion

It is important to understand that each one of these examples represents a series of monthly $500 investments when all criteria are met for that month and not one lump sum investment on the date listed under DFI.   That date is simply the first month when all criteria were met.  As you can see by the differing amounts under TFI there a varying number of months for each where investments could be made.

If you had been able to make all of these investments you would have created a “dividend collecting fund” or “business” with a dividend yield of 19.6% at the end of 2016.   Just to be clear, that means you would be receiving almost a 20% return on your investment in 2016 just from dividends alone.  And the value of the shares in your “business” would have grown by 578% for an annualized rate of 29%.  By comparison, the S & P 500 rose from 3,754 to 19,762 during this period for a total gain of 426%, 19% annualized.  That means our “fund” has outgrown the S & P 500 by 47% a year.  I can live with that.

The period of 1994 through 2016 had two serious corrections (2000-2003, 2008-2009) as well as several extended periods of growth.  In other words, it basically tracks with what occurs in most 20+ year periods.  The resulting dividend yields range from 6.4% to 65.5%, so it’s apparent that not all investments are extremely successful.  But we can say that all are successful in some measure because even 6.4% is greater than the original yield and the smallest profit gain is 161%.

Because we can’t predict the future and therefore we can’t predict which investments are going to perform the best, I find it’s best to invest in as many companies meeting the criteria as possible each month.   In doing so, we will have covered as many bases as possible.  And, we will have created a “naturally” occurring diversified set of companies for our “dividend conglomerate” in the process.

That all sounds great but let’s play “devil’s advocate” for a minute.  What if the company we choose has issues or goes bankrupt?  Well if the company goes bankrupt, you’re mostly likely out of luck.  One would hope that these large “necessity product” type companies would never arrive at that point.  Or if they did, we would be paying enough attention to our “business” to sell our shares before that day arrives.  Or another legacy type company would step in and takeover the ailing company.  There are certainly no guarantees.  But there is a “very” high probability that we won’t face this problem.  What is more likely is that one of the companies will have some issues.   Almost every company does at some point.  Remember Coca-Cola and its ill-advised decision to change the recipe of its flagship drink.   Warren Buffett sure does.

If you look at the list, you will notice that there are several major drug companies listed there.  Let’s take Merck (MRK) for instance.  From September 2004 through September 2011, the quarterly dividend from Merck remained at 0.38¢.  During that period there were a lot of mergers and consolidations throughout the major drug industry so that Merck (and others) chose to use their cash to buy other companies instead of raising the dividend.  Pfizer (PFE) actually reduced its dividend twice.  But importantly none of these large drug companies totally omitted their dividends.  Therefore, as shareholders we continued to receive dividends and reinvest those dividends when stock prices were low.  The list shows that for Merck, reinvesting dividends allowed us to create a 11.3% yield by the end of 2016, where just collecting dividends would have resulted in only a 6.5% yield.  The moral of this story is as long as the company remains in business and paying a dividend, reinvesting helps overcome issues and problems.  It’s just another reason to reinvest dividends if you’re not in a situation where you depend on them for income.

Not to belabor the point, but Conagra Foods (CAG) is another good example of this effect  because it has struggled to grow and find profits recently, but yet reinvesting has created a 6.4% yield versus what would be a 4% yield.  Is either exciting after years of being invested?  Of course not.  But it is still higher than the original entry yield and has produced a 173% profit over 17 years.  So while it’s not optimum, it is still above water.  Reinvesting cures most ills.  While there’s no always or never, there most certainly is a “usually.”  So, I feel very good about the prospects for a “reinvesting” business going forward.

And I will add one final note.  This will seem a bit counter-intuitive (the market often is) but in many ways it is often better for our companies to not experience significant price appreciation during our reinvesting period.  If they do, we certainly won’t turn it down.  But if the dividend continues to grow but the price remains somewhat level, we will be able to obtain more shares at these lower prices through reinvesting.  Which ultimately leads to more dividends produced and an enhanced circular dividend-to-reinvesting-to shares held  process going forward.  While it’s not included in the list, Intel (INTC) was a very good example of this principle from 2002 through 2013 when its price stagnated  while its dividend grew substantially.   Selective investing and continual reinvesting during this period would have made it possible to accumulate a significant number of shares so that when Intel eventually began to rise in value, the “dividend collector and reinvestor” would have been well positioned to benefit from this rise.

Buy low, hold, and reinvest is a winning strategy the vast majority of the time.