Guest Interview, Dividend Growth Investor
(Edition Number: 24)
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When I first joined Twitter, back in February 2020, the man behind Dividend Growth Investor was actually one of the first people I discovered and followed.
I came to Twitter with no understanding that ‘fintwit’ was a thriving subsection of the Twitter DAU base. So, DGI, to me, was one of the first glimpses into that.
Sadly, and this is entirely down to me probably be annoying, I was blocked for the better part of 6 months before one day realising I was unblocked.
Since then, I have had many discussions with DGI, and each has been pleasant, humourous, and informative.
With a mutual love for writing, I wanted to get DGI on the interview segment to discuss that, but more importantly, to discuss a topic that seemingly comes into and out of popularity in a similar cyclical manner as the stock market itself.
That topic is dividends.
More specifically, dividend growth investing.
The two are often confused, and I feel there is a range of misconceptions and ill-will sported on the idea of investing for dividend growth.
I am always on the prowl for differing perspectives here at Investment Talk, and this edition will mark the first guest who has an approach like DGI’s.
“It is helpful to try to think through various issues, and writing them down helps out a lot. Investing is not just about picking the next big thing. It’s about finding a strategy that suits you, which you can stick to. I strongly believe in having a process, that carries a certain amount of weight and helps navigate the markets. It’s also about continuously improving.
You need to think about types of companies to buy, when to buy, how to build and manage a portfolio etc. I’ve made many mistakes, which are pretty obvious if I look at my transaction history or blog history. So keeping a blog definitely helps in recording things, and keeping me honest with myself and my thought process.”
Dividend Growth Investor
Many of you will recognise today’s guest as the man behind the @DividendGrowth Twitter account, which sports the below profile photo.
DGI (as he shall be referred to henceforth), has a focus on Dividend Growth Investing, which was fashioned ~15 years ago.
Today we get into the meat surrounding the misconceptions between general “dividend investing” and “dividend growth investing”. Both of which, are typically cast aside and labelled as “hunting for yield”. That could be late-cycle kind of talk, however.
The reality is that the latter is quite different to the former.
I am not personally an investor who is focused on yield. I do own dividend-paying companies, but their dividend status is not something that is placed high up on my list of important considerations when first studying a business.
I do, however, love reading about these investment strategies that lay the importance of returning cash flows to the investor. That is where I first began in my investing journey, and I imagine I will return to it, in some fashion or capacity, later in life.
Understanding the full spectrum of investing styles is uber important.
DGI has been operating the Dividend Growth Investor blog for more than 13 years, after first creating it in 2008.
Here, you will find the full body of his work, stretching over decades, where he covers educational content, opinion pieces, and direct insight into a range of dividend-paying entities.
Good morning DGI. Very happy you accepted my offer to come here today.
So, we will get into your process and your preference for dividend growth in just a moment.
But first, I think it’s always useful for the guest to learn a little bit of the backdrop.
So, could you maybe tell us a little bit about your history, who you are, how you discovered investing, and then maybe a sequence of events that has led to you where you are today?
I am an individual investor, who manages his own personal account. My goal is to generate a sufficient amount of dividends to cover expenses and to help grow those dividends above the rate of inflation over time.
I have followed financial markets for a long time. Became fascinated with watching the business channels in the late 1990s as the dot-com bubble was gaining steam. The 2000 – 2003 bear market was pretty fascinating to watch, as many dot-coms deflated or went bankrupt.
Luckily, I was a teenager during that time, and I didn’t have a lot of money to lose. My learning at the time focused on more short-term patterns and learning about charts and forex markets. Anything prior to graduating college and getting my first job is basically just nothing to write home about.
We also had the Enron, Worldcom, Arthur Andersen, Adelphia, Tyco scandals at the beginning of the century. The one positive fact about all of that is me getting interested in accounting, and enrolling in school to learn it and get a degree. I was pretty busy in school with work and coursework and extracurricular activities. I had to pay for my own education, so that was time-consuming, but helped me graduate debt-free.
I did learn to be frugal at that time. However, I’ve watched my parents be frugal as well so that to me is perhaps the reason for why I am here. While they didn’t invest in equities, they were able to instil frugality in me.
I didn’t really have a lot of money to invest until I graduated college. That’s when I really became serious about investing my money in a way that could generate a reliable return I could live off. I really loved my first job, but my company was a little shaky. So I tried to save as much money as I can, and invest it in a way that can produce returns to live off. I did lose that job around the time of the GFC, which made it tougher in a way, but also liberating. I used all my free time during my jobs to learn about investing, and research companies. That was neat. You can say that this knowledge is paying dividends.
Back when I graduated college, I did some research and found out some information on dividend growth investing, which clicked with me.
It made sense that some mature companies with defensible business models can grow earnings over time while also generating more cashflows than they know what to do with. They send that cash flow to shareholders and raise those dividends annually. In a way, the dividend is more stable than the share price, which makes it a decent way to live off an investment portfolio. This of course is the case, provided I picked the right type of business and diversified just in case.
I liked the smoothness of the Dividend Income chart versus the share price chart, so I was sold on it. Perhaps I value certain predictability, which is where the dividend aspect is appealing to me. It definitely is easier to own a stock that everyone hates, if I am getting a regular and rising dividend in the process, and basically getting paid to hold. Psychologically, it’s easier to ignore volatility, in case of course I am trying to buy more.
I’ve been investing in Dividend Growth Stocks for 10 – 15 years now, but it’s definitely been a learning curve.
I have always invested with the end goal in mind, notably achieving financial independence. I value the ability to receive cold hard cash every 90 days, which I can use as I choose. That’s because the road to Financial Independence is not straightforward.
I’ve lost jobs in the past decade or so for various reasons, and have bounced back. However, it is definitely good to know I have my own “unemployment insurance” fund to help me weather the storms.
Life comes with ups and downs, but we just need to keep plugging away. My goals have definitely evolved, from trying to “retire” outside the US and exploit geo arbitrage in my early years, to perhaps seeing how far I can compound my nest egg, before tapping it and stopping work for good.
In a way, it is important to be flexible, and understand that there are multiple possible outcomes in any activity, be it investing or just life decisions in general.
In essence, it is a fairly simple journey of graduating college, starting a job, and finding myself into money for the first time. So I decided to invest it. And I have been following this pattern of saving something every month and then investing it for about 10 - 15 years through the ups and downs of markets, economies and life.
Thanks for that.
So, you have been writing on your blog, Dividend Growth Investor since 2008. Clearly, you have been doing this a lot longer than the recent substack hype.
I would like to dig a little deeper into that.
So, what incentivised you to create a blog in the first place, and what is it you do there, for readers who may not be aware?
Then, maybe following on from that, what have been some of the most critical lessons you have gained from writing this blog for so long?
After more than a decade, it’s surely a significant aspect of your life I would imagine?
I have about 14-15 years of actual professional experience as an accountant/cpa. The fascinating part is that the blog is one activity that I have done the longest in my life. It is sort of like second nature in a way, which is good and bad.
It’s good because, in my mind, I often think about various blog article ideas. So I actively think about it much more than I probably should, as I have a lot of other responsibilities. This helps in my investing, as I get to put ideas on paper, and hopefully learn from them, and ultimately profit.
I really started it on a whim, after reading up about investments in the year before. It was a good sounding board to put thoughts into a personal type of journal. Most importantly, this journal would be something that would force me to do the work to form an opinion on something. So if I like to invest in some company, posting a review of it on the site is my way of providing some justification for it. Otherwise, I was afraid that I would just go ahead and buy investments, without really doing much research.
While my analyses are not very deep, they are at least something to point to and something that makes me think about the investment I may be making. It is very helpful to write thoughts down on paper because you can see what you are thinking. Hopefully, I will spot issues I have right away or I will at least identify some dangerous patterns after a while.
I was also hoping to reach out and learn from others as well, as I didn’t think I know that much. Obviously, I still have a lot to learn. If you look at old articles, you can see some growth along the way.
It is helpful to try to think through various issues, and writing them down helps out a lot. Investing is not just about picking the next big thing. It’s about finding a strategy that suits you, which you can stick to. I strongly believe in having a process, that carries a certain amount of weight and helps navigate the markets. It’s also about continuously improving.
You need to think about types of companies to buy, when to buy, how to build and manage a portfolio etc. I’ve made many mistakes, which are pretty obvious if I look at my transaction history or blog history. So keeping a blog definitely helps in recording things, and keeping me honest with myself and my thought process.
The nice thing about the blog is that it has provided me with the incentive to be disciplined in writing down investment reviews, thoughts on strategy etc. Basically, I have written something for the website almost every single week for the past 13 years, except for a couple of weeks over the years.
This discipline has translated somewhat into discipline when it comes to investing and saving. But it also has provided me with the incentive to immerse myself in investing, plus a provided written record of why I may have done certain decisions. It is fascinating to look at old reviews, and see how things turned out, and see what can be learned.
I did start it on a whim, but I have hoped to try and inspire others to take their financial lives into their own hands. While I understand that not everyone will be interested in Dividend Growth Investing, I do believe that almost everyone should be doing some sort of investing. The blog gives me a platform to reach out to other smart investors, who I can learn from. It’s helpful in idea generation too, as I frequently have folks coming up and asking me questions about some good ideas. But I generally enjoy it, as it is a type of “hobby” that pays dividends.
It is fascinating to think of blogs as business, as you can generate revenues from advertising or creating your own product.
After doing this for about 13 years, and seeing a lot of ups and downs, I am a little sceptical about being a full-time content creator. But I’ve dabbled, and it has been a fascinating endeavour that gets me thinking about marketing etc. The most valuable part is the opportunity to connect with others, like yourself for example.
I may not have been offered the opportunity to be interviewed by you if I was just a regular Tweeterer. I also get the opportunity to hear ideas from others, which I may have missed, the same way readers of my site may get some research from me.
But long story short, my blog has kept me disciplined, and on task to save and invest for my retirement goals and objectives. I probably would not be where I was without pushing myself. It’s a hobby on a topic that is endlessly fascinating, so it keeps me going.
So, I have not had many investors on this segment who are primarily focused on dividend investing, or rather, dividend growth investing.
There seems to be a lot of misunderstanding, or misinformation, surrounding the topic/strategy.
I am wondering if you could potentially lay out the case for why an investor would be suited towards dividend growth investing, and what are the benefits and downsides of that approach?
A lot of people confuse Dividend Investing with Dividend Growth Investing. They also believe that Dividend Growth Investing is about chasing yield. This is a misconception.
Dividend Growth Investing is a strategy that focuses on companies that regularly increase their annual dividends. I do not just want a dividend, but a company that can grow that payment over time, and that payment is coming from rising earnings over time. I view a streak of consecutive annual dividend increases as an indication of quality, which means that a company would be placed on my watchlist for further research.
There are approximately 140 companies in the US, which have managed to increase dividends for at least 25 years in a row, and a little over 470 that have managed to increase dividends for at least 10 years in a row. These are very impressive numbers.
A lot of Dividend Growth Stocks are boring, mature leaders in their industry. Many great companies tend to become dividend growth stocks. These are companies that have stood the test of time, countless shocks, wars, upheavals, adapted and survived, while also growing earnings and dividends along the way. I enjoy the slow and steady approach to investing, the slow change in the companies and industries that dominate dividend growth investing, and the long runways ahead.
Dividends seem to be counter-intuitive to a lot of folks somehow. I don’t view it that way. There are a lot of great quality companies that tend to grow dividends for a long period of time. This is a testament to their business model, which allows them to not only grow the business but compound net worth and shower shareholders with a rising stream of cash each year.
Basically, a business sells things and hopefully earns a profit. The business hopefully has some capable leaders who evaluate how much is needed to grow and maintain profits, and then they distribute the rest to shareholders. If management believes that the company can generate a high ROI on all capital, they won’t send it back to shareholders.
But in reality, a lot of established companies that dominate their industries end up generating much more than they know what to do with. Hence, it is best to distribute that money to shareholders. Only a certain type of company can not only grow and maintain that business but also grow dividends annually. You need to have a certain type of moat, brand recognition, intangible competitive advantages, in order to achieve all of that.
There are companies like McDonald’s, Altria, Johnson & Johnson, PepsiCo, Procter & Gamble, Brown-Forman, Diageo, Hershey, that have managed to grow dividends, growth earnings, grow the business, deliver outstanding returns all at the same time. These are the types of companies that I tend to focus on. They are large, stable, predictable and have an everyday type product/recurring type product that people buy.
For example, Altria distributes almost all of its cash flow to shareholders in the form of dividends, and some in buybacks. Yet, it has still managed to grow earnings and the value of the business. Altria has managed to increase dividends annually for over 50 years in a row.
A lot of folks believe that businesses should just reinvest everything back, but that’s not really how it works for everyone. It may work for some companies, at some early stages of their lifecycle, and for some amazing capital allocators like Buffett, but these are more of the exception, rather than the rule. Even for Buffett, there are limits to growth, as evidenced by the past 15- 20 years versus his benchmark. For a lot of companies, it’s better to send excess cash to shareholders in the form of dividends, than waste it on expensive acquisitions, subpar projects that divert management focus or let it rot on the balance sheet.
Corporation management are regular people, who may get the urge to do something silly and spend the cash, just like most people would do if they found out they have $2,000 in their pocket.
- I believe that owning a good business trumps having exceptional management.
- I believe that there are limits to how much capital you can throw at a business, and still earn a good incremental ROI on it
- I like the cistern analogy that a lot of businesses that drown in cash may end up corrupting management into doing bad acquisitions, working on pet projects that do not deliver good returns, spend on lavish offices and corporate jets etc.
- Some of the best businesses tend to require little capital to run and grow and tend to shower shareholders with more cash. For example, Buffett acquired See’s Candy in 1972 for $25 million. Through 2007, that business managed to distribute over $2 billion in dividends to Berkshire Hathaway in total, while only requiring an extra $32 million to be reinvested back into the business.
So to summarize, Dividend Growth Investing is a quality filter in a way for me. The neat thing is that you get a certain portion of your return in the form of dividends. If you compare the share price chart of a business over a period of time and the dividend per share chart for said business (assuming a Dividend Growth type), you would notice that dividends are more stable than share prices. In other words, I am relatively certain that a business like Johnson & Johnson will pay $4.24/share in dividends over the next 12 months. On the other hand, I have no idea if the share price will be above $167/share or below $167/share.
I invest with the end goal in mind, which is to generate a certain level of income to pay expenses with. Dividends are very handy in that regard because they are more stable than share prices, they are more predictable, which make them an ideal source of income for a retiree. Plus, dividends tend to grow above the rate of inflation over time, which keeps purchasing power in check. Traditionally, dividends have tended to account for 40% of annual stock market returns, though that tends to decrease in bull markets and increase in bear or flat markets.
A lot of folks tend to dismiss dividends. I blame traditional Finance for that. However, it is also a reflection of the type of market we are in. During the 1990s, when share prices kept going up, no one cared about dividends.
During the first 10 - 13 years of this century, people did care, since dividends provided almost all of the stock market return. In the past decade or so, dividends are getting much less spotlight, since prices are going up.
A big misconception on dividends is around the ex-dividend date. That’s the date on which the company stock price is reduced by the amount of the dividend.
A lot of folks see this and reach out a crazy conclusion that dividends don’t matter, that dividends are the same thing as selling stock, or that dividends come from the share price. That’s because folks lump everything together as part of the total return calculation, and then reach the conclusion that they don’t matter.
If you sit and think about it, share prices are determined by the collective opinions of buyers and sellers. This is why they fluctuate over time, because opinions change, even if actual fundamentals do not change as much. In fact, share prices fluctuate more widely than fundamentals. Therefore, these share prices fluctuate more widely than changes in earnings/cashflows.
Dividends are determined by the boards of directors and come directly from earnings/cashflows. They tend to be more stable as they come from fundamentals. This of course is more accurate for a dividend growth type stock. Not so much for US Steel for example.
If prices are more volatile than dividends, they cannot be the same thing.
While the stock price is reduced at the ex-dividend date, lots of folks don’t understand that the price probably tends to increase slowly between ex-dividend dates by the amount of the dividend. I observed this phenomenon when a company that Buffett acquired for $72.50/share distributed a dividend of 51 cents/share, and the share price fell to say $72/share. However, the stock price then slowly went up to the $72.50/share acquisition price.
When a company pays a dividend, this in effect can unlock value, that’s otherwise trapped. As discussed above, you don’t want too much excess cash sitting on the balance sheet for various reasons. This is evident when a company does a special dividend. For example, Costco has paid several special dividends, and the stock usually increases by the amount of it. The people that only focus on the ex-dividend date will definitely miss it.
Going back to my overall strategy, there are downsides. Notably, if you select the wrong companies, you may not do very well. Some investors tend to chase yield, which does not work very well.
I have personally chased yield and can attest to that.
This is why you want to diversify. Many DGI type companies are quality, which somewhat reduces wipe-out risk for a diversified portfolio of dividend growth stocks.
The other risk is that some mature quality companies like Google or Facebook, which would have otherwise started paying and growing dividends in another environment, are not embracing the Dividend Growth Company lifestyle. They are doing buybacks or just acquiring companies and running them into the ground (in the case of Google).
The risk is that companies stop sending out dividends, which reduces the pool of investable opportunities. And you may miss out on them.
The third drawback could be taxes. When a dividend is paid, a portion of investors may owe a tax on it. I say a portion of investors because a third to a half of investors in US stocks are either entities that are not taxable for one reason or another.
For example, a pension fund, a foundation, or a charity will not be taxed on dividends. Neither will an individual who manages their tax brackets, or invests through a retirement account. A portion of investors are not taxable, because they do not earn as much income.
A retired couple with $100,000 of annual dividend income and no other source of income will pay zero in taxes. If they earned $100,000 in salary income, however, they would be taxed at a marginal rate of 22%.
But someone like Bill Gates definitely gets taxed at 23.80% on dividends, albeit someone in our taxable income probably can get taxed at around 15% on dividends and/or realized capital gains. Of course, Bill Gates also sells stock regularly in an effort to diversify, so he pays a lot of taxes on those too.
But my point is that taxes can be managed.
The other issue is that many folks assume that you need to earn the highest returns in order to retire.
That may help in the accumulation phase, but in the distribution/retirement phase, the sequence of those returns really matters a lot. This is where the misconception that share prices and dividends are the same thing can really bite you. Dividends are more stable, predictable than share prices, which makes living off dividends in retirement a better idea than selling stock.
Basically, the sequence of returns matters, and if I live on the stable portion of returns (dividends), I can afford to ignore share price volatility.
For example, if you owned $1 million worth of a stock like Amazon in 1999, you are now worth a lot more. However, if you started selling $3,333/month to cover expenses in March 1999, you would be out of money by 2001. That’s because the stock was very volatile, having multiple high drawdowns. The sequence of returns made it in a way that you run out of stock to sell because your expenses are fixed in dollars, but the decline in share prices leads to you selling a higher amount of stock than previously thought.
On the other hand, if you had bought a stock with a 4% dividend yield that simply grew dividends at the rate of inflation, and the share price increased by just the rate of inflation, you would still be retired. While in the accumulation phase you may not have ended up with the most money, you also had a lower wipeout risk.
If you want to retire and enjoy life, this slow and steady approach makes it easy to sleep well at night. Though a little Heineken may help out too.
Fantastic, thanks DGI.
Following on from that, I think it would be great to get a better understanding of how you invest.
Could you walk us through that process?
Perhaps explaining what it is you look for in a company, how you opt to decide your weightings, do you reinvest all dividends, is it entirely dividend focussed, how do you generate ideas for new positions, and so on.
Basically, an overview of your investment style, with some rationale thrown in.
In my investing, I focus on things within my control first.
Namely, identifying my goals and objectives, the amount of money I can invest, the strategy I choose, the ability to keep costs low and the ability to exhibit good behaviour.
When it comes to good behaviour, I try to invest money every month and try to avoid timing the market. I also try to avoid selling, as much as possible.
This also means avoiding chasing of fads, and sticking to my strategy. It also means staying diversified, and not risking more than say 5% on a single position. Plus, I would avoid having more than 5% of dividend income be derived from a single position as well (this could be an issue with higher yielding companies).
My idea generation process is definitely a multi-staged one. In general, I focus on the Dividend Growth Investing universe of companies in the US that have managed to grow dividends for at least a decade. I have reviewed many of these companies, and have an understanding of the ones I may be interested in purchasing at the right price. I may screen for certain factors, and check for prices/valuations from time to time.
I also review the list of dividend increases regularly, in an effort to keep updated on companies and see how they are doing. This exercise can get detailed quickly if I start going through press releases, filings etc if something catches my eye, or not at all.
I like to talk to investors and see what they are doing. A lot of times, the advantage of interacting with others for so long is that many smart investors end up asking my opinions about companies. That’s a big advantage for me, though not always 100% for them.
Quite often, the best ideas may already be in my portfolio. One of the things I have picked from Buffett is that if I like a company, the best way to monitor is to buy a few shares. It makes it very helpful to monitor a position when information is thrown at you (press releases, dividends, annual reports, share prices). It also helps to be prepared if the right circumstances are present.
I try to buy a few companies per month with the fixed amount of capital I can deploy. I try to allocate an equal amount to each company. I also have overall portfolio weights in my mind when adding to a position. But the specific companies are also a product of the market environment. I have often had anywhere from 5 – 15 companies to invest in. If stocks sell off, that number can increase, so I would focus more on the ones that are rarely on my buy list. If stocks keep climbing valuation wise, then I just need to work harder to find something to invest in.
So if I put $1,000 to work and I find 5 companies, I would put roughly $200 in each. I would continue adding $1,000/month in my best ideas until I reach a certain amount that I cannot add to.
So if I had a portfolio worth $50,000, with 50 positions worth $1,000/each, and I had to choose between putting $100 in stock A that I own or $100 in stock B I don’t own, I would choose B. But I would choose B only if I thought I could build a decent position size to say $1,000. However, if I have say $2,500 in stock A and $500 in Stock B, I would choose B, all else being equal. If I have $500 in both A and B, I would add to both 😉.
I tend to build positions slowly, and over time. This is in a way to protect me from making mistakes.
So if I buy a stock that keeps sliding, that is fine to add further on weakness. If I build slowly, I tend to also have time to react to changes in my thesis if I was wrong. And by having a limit to how much of portfolio value I am willing to risk, I also will stop adding to a bottomless pit too. The downside to this approach is that dips in great companies that are seldom cheap are very rare and therefore you will have to really pounce on those. So buying slowly protects on the downside somewhat, but it also limits the upside, because it may take me a while to build a position in a stock that is cheap once every 3 years.
I do this with companies where I buy every month. When I have had a lump sum however, I would just find a larger group of stocks, and just put an equal weight amount there and let it reinvest and compound, without doing much afterwards. Perhaps I may sell after a dividend cut, and after an acquisition happens. I would also reinvest dividends automatically in this approach.
This approach works for say investing in a Roth IRA, where I have a $6,000 limit of how much I can invest in new money per year. Therefore it just makes sense to put the money in the account, find amount of companies to buy, and let it ride. Also works the same way if I have an old retirement account that I can transfer to a self-directed account.
Historically, I very rarely reinvested my dividends automatically. The only exception was in retirement accounts, as discussed above, because I put the money at once, and due to commissions/fees and amounts to invest, it was uneconomical to sit in cash and wait. For taxable accounts, I basically took the dividends in cash and lumped them with new cash contributions to invest in my best ideas for the month. It makes little sense to reinvest the money in companies that are overvalued.
In the past year or so however, I have started to challenge this assumption. I realized that from a trade-off perspective, it was actually easier to just hit reinvest. On average, my overvalued companies tended to stay overvalued and continue doing really well, while some of the values did ok, but not as well. The cheapest ones did ok at the beginning of my journey, but not so much at the tail end. In other words, from an effort perspective, it’s just easier to reinvest automatically.
All of my individual investments are dividend growth focused. I would hold a company that is not dividend focused when a spin-off occurs, and it takes a while for the new company to establish a dividend policy. In general, I would sell after a cut. I rarely sell, however.
I take a long-term approach of essentially riding the long-term trend in fundamentals, namely dividends. I wait patiently.
The only non-dividend company I hold is Berkshire Hathaway that I bought because I really loved learning about Buffett. I’ve read his letters, books about him etc. I realized that given the amount of time I have spent, the best way to invest like Buffett is to invest with Buffett.
I have held employer stock in my accounts, as part of compensation or as part of an incentive plan to buy it at a discount. Most of my employers that have been publicly traded have offered the option to buy their stock at a 5% - 15% discount, and the ability to sell it pretty much right away for a quick profit. They were not dividend paying at the time.
I do hold Index Funds in my 401 (k) retirement account at my employer. I put a portion of my paycheck to it, which helps reduce taxes. I like the diversification aspect of that since it covers blind spots I may have (for example, not owning Google or Facebook directly, but through S&P 500 for example). It is basically mostly in S&P 500 type funds, and a little in an international fund.
Being a long-term investor, sometimes the hardest question can be when to sell.
I tend to be more long-term orientated, and stick to a pre-defined set of rules which, if broken, will allow me to sell or trim a position down.
What does that process look like for you? When would you be likely to sell a position?
One of the best lessons I ever learned is to analyse past transactions.
In doing so, I found out that when I sell, I am usually doing a big mistake. I have had very good “reasons” to sell, which always sounded logical. But in reality, selling has been a major mistake for me overall.
Obviously, it has worked for some companies, but the ones where I sold early are just too tough to swallow, especially as time marches on. The idea is that if you sell for some reason, you also need to be flexible and try to get back in if the facts prove you wrong. For example, a reason I used to sell for was “valuation”.
But in reality, it was a mistake, because no two companies are alike and valuation is pretty subjective and company dependent. Plus, in a taxable account, you pay taxes on large capital gains recognized in this turnover. Hence, I sell very rarely now. And I wonder if that’s too active as well.
I basically try to ride a long-term trend in a company, so I would hold it, for as long as the dividend is not cut. My assumption is that when everything goes according to plan, the company keeps earning and growing the pile, and grows the dividend. But if the dividend is cut, it shows me that something material has happened in the business.
Basically, I did this rule as a way to protect myself from getting in love with a business and holding it for sentimental reasons, even if fundamentals are starkly different and telling me it’s time to go play somewhere else.
It is very likely that when a dividend is cut, this is also a cyclical low that I am selling at. But, my goal is not to time the market. My goal is to identify companies that can grow earnings and dividends, and hold them for decades. I do not like surprises, though they are an objective way of knowing that something material has changed.
Now, if the business issues are temporary, in an ideal scenario they would resume growing dividends back, so I may get back in.
In general, the best decision on selling is to never sell. Now, a portion of the companies I never sell would be disasters. But a tiny portion that I never sell could turn out to do fine, and more than compensating for the disasters.
I have heard you discuss the matter of savings rates quite often, and how important they are to one’s investment success long term.
I have always been a believer in spending what you have leftover from saving, rather than saving what’s left after spending.
Personal finance education is just as important as learning how to read a balance sheet for an individual investor, in my opinion. It’s the bedrock of great investing.
How important do you feel savings rates are to investing for the long-term, and why?
Your comment reminds me of the following Buffett Quotes:
“I’m not interested in cars and my goal is not to make people envious. Don’t confuse the cost of living with the standard of living.”
“Do not save what is left after spending; instead spend what is left after saving.”
“If you buy things, you do not need, soon you will have to sell things you need.”
I believe that your savings rate is very important. First of all, without savings, it is next to impossible to accumulate capital as an investor. You may be the next Buffett, but if you never save money to invest for your future, it would be hard to accumulate much. Perhaps this would explain why people who do not save money for one reason or another end up hoping for an inheritance, or a lottery type investment payoff.
Your savings rate is the percentage of income that you save. You get there by managing your income and your expenses.
Savings is just half the battle, however. You need to invest that money, in order to earn a return on it.
It is very fun to play around with different assumptions, in order to see how impactful your savings rate is. This is particularly fun when you think about planning and investing for retirement. Theoretically, if you have 25 years’ worth of expenses put away, you are basically financially independent. That’s because a 4% real annual return would provide you with 1 years’ worth of expenses. So, you have your capital work for you, so you don’t have to. In today’s environment, I would use a real return of 3%, so that would mean having 33 times annual savings. But hope you get the idea.
Accumulating 25 or 33-years’ worth of annual expenses is dependent on your savings rate, the return you generate and how long you can afford to stay invested.
If you save 80% of your income, that means you live on 20% of your income. This means that for each year that you work, you save 4 years’ worth of expenses. So, after 5 – 6 years of working, you can retire. (Assuming some modest returns on the money of 5%/year)
If you save 20% of your income, that means you live on 80% of your income. This means that for each four years that you work, you save 1 years’ worth of expenses. Assuming a 5% real return, you have to work for about 37 years to retire.
At a 50% savings rate, it takes about 17 years to retire from employment, and focus on being a full-time investor.
You can see that in the accumulation phase, your savings rate is super important. Even more important than generating very high returns. In retirement, it is important to generate a steady rate of return to live off, and avoid running out of money.
Savings is a tricky matter because everyone has different circumstances. I believe it is best to try to save as much as possible, save as much until it hurts in a way. That doesn’t mean living like a monk. But it does mean understanding opportunity cost and the power of compounding. Each dollar saved in your 20s at a 10% rate of annual return can turn into $117 in 50 years. That’s just amazing, but few think this way.
I try to be aware of my spending and savings, so try to be mindful to avoid unnecessary spending. Many companies are great at marketing their products as needs, even if they are wants. They’ve convinced consumers that if they do not have the latest hot gadget or the expensive car, they are depriving themselves. It’s genius really of the lengths they have taken to convince folks to spend money. In my case, if I go to the grocery store without a list, I end up spending more than I should. Or if go to the store and I am hungry, I may end up spending on the impulse chocolate candy bars that are located by the checkout lane. Long Hershey and Mondelez.
In general, I try to save and invest automatically, by diverting a portion of my paycheck to my investment accounts. But I also try to save and invest what is left over after a month of spending too. My portfolio is entirely in equities. I do keep a savings account in cash for specific short-term goals and for my emergency fund, but that’s it.
I guess I have a house and a car, which apparently have beaten the S&P 500 in the past year. But I doubt they will over the next 30.
Part of the parcel of investing with a dividend focus is understanding the company’s ability to a) comfortably pay their dividend and b) have the ability to continually increase their dividend each year.
How do you ascertain dividend safety?
What are some of the steps that you take to ensure a company has the ability to do those two things?
Then lastly, are there any other ways you ensure dividend health?
A lot of the dividend growth stocks I follow are boring and somewhat predictable. Their products or services lead to a lot of small, recurring purchases by consumers. Though not all of them. I believe that having some type of a product that serves a basic need helps counter the ups and downs of the economic cycle. For example, people keep shopping at Wal-Mart even during a recession. People also eat at McDonald’s, even when times are tough. At least that has been the case in the 2007 – 2009 and 2020 recessions. This bodes well for earnings and reduces the risk of a dividend cut.
In general, I look for growth in earnings per share over time, and a well-covered dividend from earnings.
If a company pays 30% of its earnings as dividends, it has some wiggle room to keep the distributions, even if earnings dips for a short period of time. Now, if we have a permanent impairment in the business's ability to earn money, they will cut the dividend, because there are no earnings to support the dividends.
The optimum dividend payout ratio varies from company to company. In general, I am not willing to see a dividend payout ratio that exceeds 60%. I would make an exception for some industries that typically pay a higher portion of earnings as dividends. In this case, I look at the trend in payout ratios to determine the safety of the dividend. So if a utility pays 70% of their earnings as dividends, and has done so for the past 10 years without cutting the dividend, I am willing to give it a chance (provided my entry criteria are met).
However, if that utility only manages to grow dividends by increasing the payout ratio, I will not look at it further. I want a business that grows dividends because they grow earnings. Without growth in earnings, future dividend growth will be limited.
So if there is a checklist, I would look for:
1) Earnings stability
2) Earnings Growth
3) Payout ratio and trend in the payout ratio
Through my reviews of individual failures and other’s failures, I have noted that higher-yielding companies have been more prone to cut dividends. This is further exacerbated if we are looking at pass-through entities, such as Master Limited Partnerships, Business Development Companies and Real Estate Investment Trusts.
It probably makes sense, because these companies distribute a large portion of cash flows to shareholders in the form of dividends. So, therefore, there is less of a margin of safety when something doesn’t go according to plan.
Which investors would you say have had the most influence on your current investing style?
Then, as a follow-up, have you always been geared to invest that way, or was this something that developed over time?
My investment style is geared towards my personality in a way. But it is influenced by the things I have read along the way.
I believe that Peter Lynch had a very big influence on me, even if I do not give him enough credit. At some point, you end up with some lessons at the back of your head, which sit there. But when the right moment comes, a sort of a message instinctively pops out, telling you what you may need to do. For example, a few years ago I had a company that was about to split in two. Many other dividend growth Investors I followed started selling their positions because the company was going to be different from the one they invested in.
However, the lesson on spin-offs unlocking value from Peter Lynch had stuck with me, and I decided to keep the stock. The company was Abbott, splitting in two in 2013. Peter Lynch is definitely someone to study, as he shows how you can do well, even if you do not own a concentrated portfolio.
I really like the ideas of Warren Buffett, but I do not really invest like him. I am a big fan of diversification, and I do like holding businesses for as long as possible. While Buffett does the same in a way, he also does a lot more trading in and out than the normal person believes he does.
He does own a lot of good businesses, which is something I strive for. I have enjoyed “The Snowball”, but really enjoyed going through some of the footnotes and then trying to uncover some of the materials present during his time. For example, I bought a few old stock manuals as well as a review of mutual funds from the 1950s. Buffett was great at synthesizing the ideas of others before him and using his unique spin to it.
This may come as a surprise, but I really was inspired by John Bogle, the founder of Vanguard. His books have a lot of information about markets and investing. It definitely makes sense that when you are investing, you need to focus on items within your control, such as keeping expenses low (taxes, commissions and fees). Turnover is costly due to brokerage commissions, bid-ask spread but most importantly, opportunity costs.
I also liked his ideas about calculating future expected returns on equities as a function of:
1) Initial Dividend Yield
2) Growth in fundamentals (earnings or dividends)
3) Changes in valuation (speculative returns)
I also liked a few charts from one of his books, that showed performance of value/growth and international/US funds. It definitely looks like these go back and forth, over long periods of time. In a way, I don’t think people should look too much into factors, although you could argue that I focus on factors in a way.
I also like the idea of the Coffee Can Portfolio and the idea of having a low turnover. On Twitter, it is the #neversell hashtag. There was a mutual fund, launched in 1935, which basically is totally passive.
It hasn’t added a new position for 85 years. Its current portfolio consists of the descendants of the companies that the fund was launched with in 1935. After 85 years, of course, you have a lot of spin-offs, mergers and acquisitions. It’s just a fascinating concept.
The coffee can portfolio is the idea of buying companies, and then tucking the stock certificates neatly into a safety deposit box (or a coffee can). Then sitting tight, and letting the power of compounding do the heavy lifting for you. Some companies may fail, others may do ok, but that approach really lets the few outstanding performers shine. Otherwise, you may be tempted to cut the flowers by selling the future performers, and watering the weeds, by adding to existing losers. We need to have the flexibility to sit tight and let companies work their magic.
The other one to note is Jeremy Siegel, the author of “Stocks for the Long Run” and “The Future for Investors”. It’s fascinating to think about stocks as one of the best wealth creation vehicles, available to so many. It is even more fascinating to read about his research on the Original 500 companies in the S&P 500 from 1957, and where they are today. Basically, a portfolio of these companies would have done better than S&P 500 itself, which is counter-intuitive to many. His analysis of the performance of the Nifty Fifty is also eye-opening.
I really enjoy reading about small investors who ended up with a lot of money, after investing in the stock market. My favourite is the Janitor-Millionaire Ronald Read, who built a portfolio worth $8M. He basically built his own dividend fund by investing in blue chips, reinvesting dividends, and staying invested for decades. What’s really impressive is the fact that Mr Read did not have a high income, as he worked as a Janitor and a Gas Station Attendant. Having a long life (he died at 92), owning a collection of blue-chip dividend payers, and having low investment costs definitely helped in generating so much wealth of course.
There’s a book that I really enjoy, it’s one I have read a lot of times. It could be instrumental to me not because of the specific style it espouses, but the lessons that are applicable to investors. It’s from Gary Smith, but don’t let the title put you off “How to Trade For a Living”.
Gary Smith was a dreamer, who always thought he would make it in the stock market.
Sadly, he spent 19 years trading stocks, options, commodities, and barely breaking even. He was very unhappy about it, and a culmination of events in 1984 led him to examine his investment record. This exercise uncovered a lot of issues, but also provided a stepping stone for his future improvement.
These lessons were instrumental in helping Gary turn his $2,000 portfolio into a million by the time he wrote this book in 2000. He’s a small investor, who has a verified track record and is the real deal.
While Gary has traded S&P 500 futures, junk bond funds, etc, I believe that his lessons learned really differentiate this book from others. It is refreshing to read a book from someone who actually invests their own money, as opposed to reading a study, an academic paper, or someone’s opinion. The lessons are about being quick and flexible, following an investment style that suits you, analysing your investment record, and looking for opportunities. He also had a nice bibliography of books to read, which are classics on their own.
In a way, he is a momentum investor. If you look at the analysis of companies I have done, I am also a momentum investor in a way – I just get on board of a company that grows dividends and stay on board for as long as the dividend is not cut. This could take me a few months, to a decade or more. I loved Gary Smith’s attitude and links to many other books, many of which are seldom discussed in my opinion.
There was also the editor of Morningstar Dividend Investor Newsletter, Josh Peters. He had an interesting commentary on dividend investing, he had a very interesting book on the topic that I enjoyed. Sadly, he left a few years ago, so I am not sure what he is up to these days. He did write a very interesting book called “The Ultimate Dividend Playbook”.
There are many ways that a new investor could allocate their capital.
Indexing, for the layman, might be a great way to get started if they are not yet comfortable with picking stocks. Some people like to simply buy what they feel will be bigger in 5 years. I see a lot of this right now.
For the most part, dividends have this wonderful compounding effect, where the earlier you start, the bigger the snowball becomes.
Counter-arguments might suggest that the potential gains, earned by high-growth stocks that pay no dividends, outweighs any advantage that a dividend portfolio may provide.
What are your thoughts on that argument?
This question puzzles me. That’s because in general, it is hard to know in advance if something is going to do better than something else.
Your initial return is a function of:
1) Initial Yield
3) Changes in valuation
There are a lot of things that can go wrong, so I don’t think we can make blanket conclusions that “high growth can do better than dividends” and vice versa of course.
Plus, as a reminder, I look at Dividend Growth Stocks, not just dividends per se. And I don’t have at my disposal a CRSP database that would help me torture data in a study, in order to reach out a certain conclusion.
The thing is that it all depends. It can depend on the specific time period you will be investing in, how you look at it, what valuations are, and how well behaviourally you do when things get tough.
It also depends on the composition of companies. Some high growth companies could turn out to be frauds. Others may turn out to be great for a while, but ultimately reach a high plateau, growth slows down, competition eats their lunch, multiples shrink. In the past, many traditional tech growth companies have been somewhat more hardware-oriented and more prone to disruption, which didn’t really bring out the moatiness that some of today’s consumer tech companies possess. Some traditional dividend growth stocks like consumer staples have been great in the past, but they may lose their way too.
In simple indexing world terms, if we assume that dividend-paying stocks are value stocks and that high-growth stocks are growth stocks (duh), then it depends on the cycle we are in.
Sometimes, growth outperforms value, as it did since 2010. But other times, value outperforms growth, as it did 2000 – 2010. High growth stocks have gone through periods of underperformance, particularly when they start being overvalued.
Then they get cheap and do better. It tends to move in long cycles, teaching folks one way of doing things, until it no longer works. Of course, a lot of growth investors I have observed tend to compare themselves to S&P 500 and declare victory. But the indexing crowd compares them to a narrower benchmark, the growth index, and they do not look as hot.
Of course, if you listen to Buffett, “value” and “growth” are attached at the hip. You can’t have one without the other. In other words, if you buy a company that grows earnings at 15%/year, you also need to think about how long this company can grow at that rate, and how much you are willing to pay up for it.
Of course, this is further complicated by the fact that when you select individual companies, you have an added risk of picking the wrong ones.
And it’s even more complicated by the fact that I look for Dividend Growth stocks. I don’t just buy a company with a dividend and call it a day. I require a dividend to be growing for so many years, that the business have some moat, and that it be bought at a certain valuation. Plus, that dividend growth should be coming from earnings growth. And each company tends to fall into three different types, each of which can be helpful throughout the ups and downs of the economic cycle:
1) Low yield, high growth
2) Sweet spot – decent yield and decent growth
3) High Yield, low growth
In general, it is an incorrect perception that something always does better than something else. There is a lot of nuances that gets lost in stating that something is better than something else.
Your returns are a function of your entry price (valuation), any dividends received and any changes in valuation. If you overpay for future growth, the business may grow but a valuation compression may really result in no returns for extended periods of time. If you look at investors who overpaid for Microsoft in 2000 at 60 times earnings, they didn’t really generate any total returns for 13 years.
They were considered a growth stock but didn’t generate returns for 13 years. Then in 2013, the stock was selling at a single-digit P/E, and you couldn’t give it away. Then it was considered a value stock and generated great returns. Of course, in the 1990s, Microsoft was a growth stock, and it did phenomenally well.
The same thing happened in the 1960s when there was a boom in tronics stocks. And again in 1972 with the Nifty-Fifty companies. Back in the 1970s, there was a company called EDS, which sold for 500 times earnings.
Even the best highest growth stock is not worth paying 500 times earnings for. If you overpay massively for it you may not make money. Even if the investment ends up compounding at 15%/year over a 30 year period overall, few would be willing to sit tight for a whole decade if the investment showed no returns. Even if fundamentals are growing.
The time period you are observing something for really matters. For example, from a historical perspective, companies that didn’t pay dividends were not the high growth ones, but the speculative ones. Hence why selecting high dividends had historically done better than non-dividend paying stocks. That has not been correct in the past decade of course. But that’s more of a testament to the fact that you should not blindly follow studies and conclusions, than anything else.
Even the Dividend Aristocrats have done pretty well since 1989 versus S&P 500. But the performance varies if you look at it decade by decade. They didn’t do so well in the 1990s and now in the 2020s. But in the 2000s and 2010s, they really did well.
From a dividend growth perspective, there have been some boring, slow companies that have really delivered fantastic returns over the past say 10 years. If we drill down, you can see Sherwin-Williams, S&P Global, VF Corporation and Hormel have done very well in the past decade or so. These are dividend growth stocks. The composition really matters, and if you follow just the high yield or high growth you may reach out truncated conclusions.
But as I said, it really depends. We should not be tricked into believing that the last ten years can simply be extrapolated over the next 40 – 50 years. But ultimately, success in investing is about finding what works that you can stick to, and then stick to your cooking. But also be flexible and adaptable, and not learning the specific lessons from a certain era, and expect them to occur again and again too.
I ask this question a lot, but I like to get a range of answers on the topic.
Investing styles are often attached to the investor’s personality.
What about your personality, do you feel resonates with your desired form of investing, if at all?
I value predictability. I also try to invest in well-known companies that I believe are somewhat predictable and somewhat relatively immune from the economic cycle. That’s a tall order of course, as nothing is fully recession-proof.
I value diversification, both in the number of companies and the ability to buy over time. I like having multiple redundancies and margins of safety that protect me from myself and my mistakes. I also like diversification in my sources of returns – so I prefer generating returns through dividends and capital gains, not just dividends and not just capital gains.
Perhaps I am risk-averse in a way. I mentioned here that my retirement goal has always been based on living off dividends in retirement. This is where I try to invest in a way that should deliver decent returns for me, but I do not have high return expectations. If the investment portfolio I own generates a starting yield of 3%, and the underlying dividend income grows at least at the rate of inflation over time, I will be a happy camper.
So basically if it generates a real return of 3%, for those who are not familiar with dividend growth investing.
Basically, this means investing $100 today and earning a $3 dividend payment over the year. The stock price may go up to $150 or down to $50 in the short run, but I would not care, for as long as the company kept earning enough money to support the dividend payment and even to grow it.
This is where analysing each company I own, trying to determine if the dividend is sustainable if earnings can grow to grow the dividend, and if there is a history of dividend increases can really help me earn dividends and reach my goals and objectives.
So if that company earns $5 today, it would have a payout ratio of 60%. If the earnings stream keeps growing at say 6%/year, it would double within 12 years. Typically the dividend would grow around the same rate as earnings. And this would obviously impact future dividend growth and the value of the business. This is where picking a good business at the right valuation is important. If I can pick this business at $100/share, that’s a P/E of 20 and a yield of 3%.
But if the business sells for $150/share, my starting yield is only 2%. In a perfect world, that business would be best to be bought at $100 than $150, but life is never perfect. I used to be very strict on valuation, but now I am more lenient. I do not have a minimum yield, and I view yield and growth and valuation together, along with how cyclical the business is, how dependable the earnings stream is etc.
I have to balance yield and growth in my portfolio construction too.
I basically do not want to go back to go, which is why I invest in blue-chip stocks with long histories of raising dividends, which earn money and mostly deliver goods and services that consumers need on a daily basis.
My investment methodology is a blend of different ideas actually. I call it Dividend Growth Investing, but that just confuses people who assume I just chase yield. I do not.
I have tried to improve all the time and have a lot of improvement opportunities.
This means looking at strategies that are different from yours, and learning from people who share different opinions from you. I spent a decade looking at ticker tapes, reading books on different strategies before I decided on dividend growth investing.
Buying companies with growing dividends is an idea taken from trend following and momentum. Buying and Holding diversified portfolios with low turnover is an idea taken from indexing. Buying companies at attractive valuations, while trying to avoid overpaying is an idea taken from value investing.
My edge is in buying a diversified portfolio of quality dividend stocks at attractive valuations and then holding on to them tightly for decades. In a world where everyone has a short attention span, and everyone is worried about losing a fraction of a penny to high-frequency traders, it pays to invest for the long term. Trying to improve can pay off larger dividends and capital gains for you down the road.
A subscriber recently (kindly) reached out to me and asked me to reinstate a question I used to ask every guest, but had stopped doing for the last few interviews.
The question pertained to the books the guest felt were most influential in their lives. I figured that was actually a really useful question, so I will be reinstating it again.
So, what have been some of the most influential books that you have read in your life, and why?
I am weird in a way that I didn’t really embrace dividend growth investing by reading a book about it. I embraced it by reading about different perspectives on the matter.
I was heavily influenced by the books of Peter Lynch. I like the idea of investing in companies whose products you are familiar with in your line of work or in your daily life. I also like his ideas of investing in boring industries and boring companies.
I may have read his books a few times, and it makes it hard for me to remember quotes specifically, but I have taken some of his lessons to heart. For example, a few years ago, I had a company I owned that ended up splitting into two companies. A lot of other investors I kept in touch with saw that as a negative, and sold their stock. I didn’t because I had remembered from somewhere that a spin-off/split may actually unlock some value.
I especially like the fact that Peter Lynch seemed to be focusing on several different types of strategies at the same time. It shows that he was learning and growing along the way, and had multiple ways to make money no matter what. He probably had a high turnover rate too but did work very hard to achieve his record. The lesson is that there isn’t one simple formula that would work all the time, under all periods. Having several strategies, and trying to adapt to conditions are the cornerstones behind the successful investment records of the greats. If you look at Buffett partnership letters from the 1960s, he also discusses having several investment strategies. Ben Graham did the same thing in the 1930s, through the 1950s.
I have also been heavily influenced by the books of Jeremy Siegel. He is the author of “Stocks for the Long Run” and “The Future for Investors”.
It’s fascinating to think about stocks as one of the best wealth creation vehicles, available to so many. It is even more fascinating to read about his research on the Original 500 companies in the S&P 500 from 1957, and where they are today. Basically, a portfolio of these companies would have done better than S&P 500 itself, which is counter-intuitive to many. A lot of folks believe that the reason stock markets are up over time, is because of new companies entering indices.
Yet, that hadn’t been the case when his research was published. The analysis on the original 500 companies, and how they would have done versus S&P 500 really worked well with the idea for the Coffee Can portfolio and with another idea for the Corporate Leaders Trust. The Corporate Leaders Trust was a mutual fund that was set up in the 1930s, which hasn’t made a new stock investment since its inception. The only reasons for turnover have been acquisitions of companies by others, spin-offs or if companies stopped paying dividends. Based on the research I have read, this portfolio ended up doing very well over time.
It is also fascinating to think about the movement in these original S&P 500 companies from 1957. Only 90 or so of them as in S&P 500 today. Some view this as equivalent to the fact that these companies failed. But failure is just a small fraction of why any of the original 500 companies from 1957 are no longer in the index. A large portion is because companies get acquired, they get spun-off, or they may end up being moved to the mid-cap or small-cap index.
His analysis of the performance of the Nifty Fifty is also eye-opening. Basically, if you overpay for a quality company, you may spend a long period of time initially, if valuation multiples compress. However, if companies continue growing as a group, you will do well. Provided of course you stick to it for 20+ years.
I also enjoyed reading that most IPO’s tend to have been disappointments. While we all know that companies like Microsoft did very well since their IPO, we also know that there are many more that did not do so well. You have to be selective in a way. It does look that IPOs have tended to do worse than say S&P 500, so that’s something I think about.
He had done some research on dividends and value, and how companies that paid a high dividend yield ended up doing better over time. That research was interesting and shows how the highest yielding stocks on S&P 500 between 1950 – 2007 did better than S&P 500. However, I do not think that has been the case since the financial crisis. It is a good lesson that past performance is not indicative of future results. Even if it is, things will not go according to a straight plan.
I loved reading some of Jack Bogle’s books. For example “Bogle On Mutual Funds: New Perspectives For The Intelligent Investor” included a chart of how dividends on the S&P 500 have been much more stable than share prices. It also showed that dividends in the US have rarely gone down. It takes a Global Depression, like 1929 – 1932 or a severe recession like 1936-1937, and 2008 to get dividends to go down. Even then, dividend payments still go down less than share prices.
Bogle’s formula on valuation is really insightful, yet so simple. In his books, he discusses how share returns are dependent in three factors:
1. Initial dividend yield
2. Dividend growth
3. Initial valuation at purchase
His life’s mission of course has been to bring low-cost investing to everyday investors. He achieved that with Vanguard, which resulted in a massive reduction in mutual fund fees. It is very likely that stock commissions are low because of that. I was definitely inspired by the idea of keeping costs low, which translates into higher returns. I am also very inspired by observing index funds because they tend to hold on to their stocks for a long period of time. Turnover is costly in terms of taxes and commissions, but also in terms of opportunity costs.
The other thing I love about Bogle’s work is his idea for reversion to the mean. There were charts in his book that showed relative performance of US versus International and Value versus Growth funds. It is fascinating that their performance was basically equal over very long periods of time. However, if you looked at a 10 or 20 years period, you could see one beating another.
Incidentally, this goes well with the idea of luck in investing. For example, we have a lot of investors who focused on the statistical definition of value that did well in 2000 – 2010, perhaps not because they were smart, but because they were in the right place and the right time. Some of them have had trouble doing as well in the past decade.
Alternatively, investors in growthtier companies did not have a good 2000 – 2010, even if their investments kept growing earnings, revenues, etc. That’s because of the high multiples in 1999 - 2000. The investors who excelled in the past decade did not do as well 2000 – 2010 or were not around. In a way, not having the scars of past losses/ruins is an advantage.
Also, focusing too much on backtests is probably not a good idea. Some of the best investors out there have managed to adapt to different conditions and thrived. They didn’t stick to one type of strategy for decades.
Incidentally, I stumbled upon Ben Graham after stumbling upon Peter Lynch, Warren Buffett, Bogle etc. I like his work too, but I won’t repeat it, because I believe everyone knows about Mr Market etc.
I do find it fascinating that Ben Graham did well-running money for the Ben Graham Partnership. However, a large portion of his wealth came from his investment in GEICO in the late 1940s, which was a multi-bagger. This just goes to show you that to succeed in investing, you may just have to work very hard to accumulate your base, and put seeds in a lot of different places, while then waiting patiently for them to turn into mighty oaks (or tomato plants).
In a way, successful investment is like farming. You plant a lot of seeds and hope that some of them would turn into tomato plants that would produce tomatoes. It definitely helps if you invest in certain types of companies/industries with a low rate of change, that deliver goods and services that people use on a daily basis, and deliver branded goods that may have a more lasting impact. For example, people would likely still drink Jack Daniels whiskey 20 – 30 – 40 years from now.
This means that if the company producing this product is available at a good valuation, it may be a nice entry into a compounder with a long runway of steady growth.
Lastly, I always conclude these interviews with some quotes. My favourite will always be Graham’s weighing machine analogy. So, to finish this off, what are some of your favourite quotes, and why?
There are too many quotes out there, but basically reading Buffett, Munger and Peter Lynch is a recipe for identifying quotes to tailor to each situation.
I like the following quotes from Peter Lynch because they communicate very clearly certain truths about investing. Notably, dealing with volatility, being patient, understanding what you own, and the ability to use your edge as a consumer to identify companies for investment. Do not sell too early and do not forget that you won’t be right on every investment.
But have the patience to hold for long enough so that the winners outpace the losers, and compensate your portfolio accordingly.
"In the stock market, the most important organ is the stomach. It's not the brain."
“In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.”
"If you can’t explain to a 10-year-old in two minutes or less why you own a stock, you shouldn’t own it. And that’s true I think of about 80% of people that own stocks."
“In this business if you're good, you're right six times out of ten. You're never going to be right nine times out of ten.”
“The person that turns over the most rocks wins the game. And that's always been my philosophy.”
“If you love a company's products or services, it usually pays to buy the stock instead”
“If you spend over 13 minutes a year on economics, you've wasted over 10 minutes.”
“Selling your winners and holding your losers is like cutting the flowers and watering the weeds.”
I like a lot about Charlie Munger
"The big money is not in the buying or selling, but in the waiting."
“The first rule of compounding is to never interrupt it unnecessarily.”
“There is only three ways a smart person can go broke:
There are too many quotes from Warren Buffett…
I like his four filters approach to selecting investments:
“We select such investments on a long-term basis, weighing the same factors as would be involved in the purchase of 100% of an operating business:
(1) favourable long-term economic characteristics;
(2) competent and honest management;
(3) purchase price attractive when measured against the yardstick of value to a private owner; and
(4) an industry with which we are familiar and whose long-term business characteristics we feel competent to judge.”
I also like these quotes, since they discuss the importance of long-term buy and hold investing, as well as the importance of sticking to quality.
“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
“Time is the friend of the wonderful company, the enemy of the mediocre.”
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
“I try to buy stock in businesses that are so wonderful that an idiot can run them because sooner or later, one will.”
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
“I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.”
“You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.”
I also love some quotes from Bogle, the founder of Vanguard.
Though perhaps some of them are more like statements:
“We know that the income risk in stocks is far more likely to be accounted for by paying too high a price for the dividends in the first place than by declining dividends"
“Look at the dividend and try to ignore the market. As I've often said the stock market is a giant distraction to the business of indexing, and in particular for the business of retirement investor. It’s the income flow from Social Security, pensions, whatever it might be, and dividend income, and that's what’s important. It's amazing how this dividend line [tends to increase over time] and the market [goes up and down over time], but they track each other in the long run."
Questions from Twitter
In this segment, we collected questions from the Twittersphere, and present them to DGI.
@illuziun: “What's the strategy with dividend investing? Ex: are the dividends reinvested back into the position, kept as cash or a combination of both? Or does that strategy simply change over time as the positions/dividends become larger?
For most of my investing history, I have allocated new cash contributions and dividends in the same way. Namely, I pooled them together, and invest in what I believe to be the best values today.
I do have a few smaller accounts where I reinvest dividends automatically back into the position that generated them, but those are dependent on certain factors. Namely, the fact that I have a limited contribution space there. For example, the Roth IRA is a retirement account that allows me to contribute money that I have already paid taxes on, but then I compound it tax-free for decades.
At the age of 59.5 years, I can withdraw as much I want, tax-free. The drawback is that I have a $6,000/year contribution limit. So if I invest it in a few companies that generate say $180 in annual dividend income, it may take me a while until I can meaningfully allocate that dividend income in more shares (more so the case when I had to pay a $5 commission). It was much easier to reinvest automatically.
If/when the investor is in the retirement phase, as in no longer working for money and living off their investments, then the correct attitude would be to spend those dividends.
@CDividendos: “Why do you like $CHD so much?”
It is a dividend achiever that has increased dividends for 24 years in a row. But it is just one company that I own in a diversified portfolio.
The demand for its products is fairly stable and relatively immune from the economic cycle. Future growth will be a function of new product development, maintaining cost, improving efficiencies, expanding internationally and strategic acquisitions. Increased focus on marketing should help in retaining and attracting more customers to buy its products on a repeatable basis.
I like the acquisition approach to growth. I also like the types of branded products that consumers can buy on an everyday basis. These serve needs, which might be some of the last items to cut in a recession. While the stock is not cheap, it may generate good returns to patient long-term investors willing to hold for say 20 years. Whoever reads this in 2041 can tell us if my statement was foolish or prescient.
The British Fund manager Terry Smith also recently initiated a position in this dividend achiever.
I analyzed that company, here.
@maddogbeck: “Dividends are almost always the first thing to go in a recession. Why would someone rely on dividends rather than fixed capital withdrawals if there is a necessity for a certain level of income to meet regular expenditure?”
If you examine the historical record of S&P 500 dividends, you would notice that dividends are more stable, predictable and reliable than share prices.
Dividends have rarely registered an annual decline since the late 1930s. You basically had the Great Depression, when Capitalism was on its Knees and dividends declined by 50%, while share prices declined by 90%. You also had the Great Recession, when Capitalism was again on its Knees, and S&P 500 dividends declined by 20%, while share prices fell by over 50%.
While some cyclical companies tend to cut dividends in a recession, these are not the types of companies that end up establishing a long record of annual dividend increases. However, there were many companies that kept paying and even raising their dividends during the Great Recession and the Covid-19 recession.
I do not focus on “any dividend company”. While dividends are not guaranteed, there are some companies that have managed to grow dividends for decades through recessions and bear markets. These companies include McDonald’s, Wal Mart, PepsiCo, Johnson & Johnson etc. A company like Ford will not make it into my dividend growth portfolio. However, it is always the companies like Ford that cut dividends.
I invest with the end goal in mind. Therefore, I focus on the types of companies that have earnings streams that are relatively recession-resistant, so they can keep earning and paying and even growing that dividend. My retirement plan is based on making profits and living off those profits. Dividends are easier to predict and live off, than share prices.
Basically, if I buy a stock today that yields 3%, and it grows dividends at or above the rate of inflation, I will be a happy camper. If I needed $30,000 to live off in my retirement, and had $1M to invest today, I could just ride into the sunset. In other words, I have modest expectations of 3% real returns, to put it in terms that a non-dividend investor may understand. Total returns are higher of course over the long run, but in the short run (5 – 10 years), anything goes. I find that having lower expectations definitely helps me, and makes me patient, so I can ride out any temporary weaknesses.
If you drill down on the individual company level, I have a much higher conviction that a stock like PepsiCo would pay $4.30/share in annual dividend income. On the other hand, I have no idea if the stock price would be above $150/share or below $125/share. No one can successfully buy the stock and only sell when it grows by $4.30/share, with the sufficient timing and consistency that dividends provide.
If your portfolio value grows faster than the amount you spend, you should be fine. But how good are you at predicting the short-term growth in investments, in order to avoid running out of money in retirement?
The problem with “fixed withdrawals” is when you have to sell the stock if it goes down in price or stays flat in price. You are eating into your capital/principal. You can easily run out of money that way. That doesn’t sound like an intelligent way to arrange retirement affairs.
Actually, selling assets to live off in retirement is akin to cutting the tree branch you are sitting on. It also reminds me of the people during the Global Financial Crisis who believed that their home prices would go up forever, so they kept refinancing their homes and spending more than they should.
@jazziyoungcat: “Do you only ever buy/add-to dividend-paying stocks for their portfolio or does this investor also have non-dividend paying growth stocks? If there are growth stocks, what is the allocation% between dividend-paying and non-dividend paying stocks in the portfolio?
I hold individual dividend growth stocks. The only non-dividend stock I own is Berkshire Hathaway. I’ve owned employer stock from time to time, but I usually sold it.
I do hold a retirement portfolio that consists of index funds. My 401 (k) includes a lot of S&P 500 and a little International Fund. I actually view S&P 500 as a dividend growth stock with 500 subsidiaries. The same cannot be said for the international fund – it’s more like a volatile savings account that doesn’t generate any returns.
@European_DGI: “What was the moment he first discovered dividend growth investing? Where was he and did he feel that kind of butterflies?”
I discovered it around 14 – 15 years ago. It was pretty exciting because it helped to invest with the end goal in mind, which is helpful in reaching goals and objectives.
Of course, like anything else in life, it takes work and effort. I have definitely benefitted by sticking to this strategy through the ups and downs of the past 10-15 years. It’s provided with the discipline to invest for my future, see results first hand, but most importantly to connect with other investors, and learn and hopefully grow there. I definitely see it as a journey, as my strategy has evolved over the past 15-10-5 years. It is very likely that I will keep learning, so my investing will hopefully be smarter in another 10 -20 years.
I would like to conclude by thanking DGI for taking the time to answer all of these questions, and for pouring so much time into them.
It can be tough to adopt a strategy that is not “in favour” (as if that matters) and I respect the work that he puts out there on a consistent basis.
I certainly learned a thing or two today.
Be sure to catch him over on Twitter at @DividendGrowth.
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Lead Analyst at Occasio Capital Ltd
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