Dividend Growth InvestingEverything about my long term strategy to replace income, by living off the perpetual growing dividends.
- Investing is simpler than you think
- What is NOT investing
- Why dividend stocks
- How this website started
- My approach to quality
- My approach to valuation
- When to sell
- Transaction updates
It’s also important to evaluate your goals and risk tolerance, because every investor has a different requirement and objective. Some investors are concerned with beating the market, others are concerned with maximum safety over the highest return, and others are concerned with maximizing their income and the growth thereof. That’s why indexing is not for everyone and why individual investing is not for everyone – and when one chooses to invest in individual stocks, portfolios will be constructed differently. So make sure to build your portfolio aligned with these goals and your risk tolerance – regardless of what the market or economy does.
Stocks are a representation of a business. There is a business behind the stock, and the operating performance of that business will reflect in the stock price in the long term. So the first thing that one should start doing is looking less at the stock price and more at the business behind the stock – and that’ where quality and valuation come into play.
That’s why it’s paramount to think like a business owner, as if you own little pieces of companies for every stock that you buy. Investing is a business. Therefore, treat it as a business. No room for emotional decisions. The more you think business like, the better you develop the required temperament.
And the more you analyse these businesses, the more you will notice that stock price follows earnings and cash flow. That’s why it’s important to consider quality and valuation. Warren Buffett always said, “Investing is simple, but not easy”. It’s simple if you think of the business behind the stock and take into account quality and valuation to make your purchase decision. But it’s not easy because the market is volatile. Price quotes are updated by the second. There is a LOT of misinformation out there, including the financial industry, which wants you to think that only professional fund managers are capable investors, and you, as a small retail investor, stand no chance in being successful. And this is far from true (more on that later).
A portfolio will reflect the operating performance of the businesses that are part of one’s portfolio, regardless if it’s a collection of stocks based on market cap (indexing) or a portfolio built by analyzing individual stocks. Quality and valuation are primary drivers of return, and a portfolio will perform accordingly to how these attributes were in play.
Investing is simple, but difficult…. because temperament is the most critical skill. Emotions (greed and fear) is what destroy any wealth, at any age, even if one decides to simply invest in SP500 ETF. If at year 9 we have another 2001 or 2008 or 1929 or even 1987, Mr Smart might become Mr Risky in no time. Meanwhile, someone with proper temperament can indeed benefit from what is perceived as Mr Risky, provided that proper controls to mitigate risks (validating that fundamentals are disconnected from stock price) are in place. Anyone can learn it if they put time and effort into it.
To understand how simple that is… it’s a business partnership. You don’t measure results in a week or a month or a year. You will know in 5 years from now if you made a good decision, which is about what a business cycle lasts. Track earnings and cash flow yearly, read their earnings transcript and annual reports, become familiar with the industry and business they operate on. When I am investing in a business, I am buying the company’s future earnings power and dividend growth potential. Companies report results 4 times a year only. Hence investing is for the long term, it takes time for stock price to follow earnings. Fundamentals cannot change as fast as the stock quotes, so the daily price quote is just a distraction that needs to be filtered out.
To be successful, have a diversified portfolio. Nobody knew that GE or C would be so adversely affected to the point that it comprises fundamentals. Like Buffett says, “buy a company so solid that any idiot can run it, because eventually, one will “. My diversification strategy is about having exposure to 10 sectors, and buy the leaders on those sectors.
Start small. You can always scale up later.
Stick to your plan. Have it figured out before you buy anything. You should know what to buy, when to buy and when to sell (as a strategy) before you begin. Follow it strictly. One of the primary reasons why investors often make bad investment decisions is because their judgment is usually based only on price movement. Price movements alone can be very misleading. A rising stock price will often lure an investor to stay calm, creating a false sense of security where they believe that all is well. On the other hand, a falling stock price usually creates anxiety and sometimes leads to outright panic. These feelings can be rational as long as they are justified by sound fundamentals. Knowing the differences between rational and emotional reactions will make all the difference.
Also, once you have your plan… ignore the noise from media, and financial institutions and use facts from the business that you’re invested on (financial results available on the investor relations’s section of the business website) to make a decision. There is a huge misconception that only professional money managers are capable to succeed overtime or beat the market. That’s because companies that sell investment products and insurance products provide data, charts, graphs, and examples to support what they are selling. They understand how uninformed people are, how uncommitted to investing they are, and how easily that they are frightened by loss of their life savings, so they capitalize on it to market and sell their products during the accumulation phase and distribution phase (annuities, target date funds, indexes, funds, mutual funds, etc.). The small investor has many advantages over the “professionals”: the ability to invest in smaller cap companies, and the advantage of not being measured into short term performance. An individual investor can do much better by investing only in businesses that meet their objectives. They can choose the level of risk, since not all stocks carry the same risks. They can choose valuation, and only buy when a business is attractively priced, instead of buying at any price. They have control on their portfolio, by selling the businesses that no longer meet their objectives, by lacking earnings growth or being very overvalued. Can’t do or control any of that with a fund.
Mistakes will be made. It doesn’t mean the strategy is broken. What matters is your consistency, so you only make rational decisions, not emotional ones. As Charlie Munger said once: “As long as you are consistent on how you value business, your degree of inaccuracy, if it’s replicated through consistency, will lead to a great model for a relative valuations. So if your valuation model is not sophisticated, does not take into account six dozen variables, well, as long as you’re applying it the same way to every company and you are looking at a lot of different companies, you will have a useful model for relative valuation which can lead to very superior investment returns.”
Investing is a business, and like every business, there will be period of locking losses. However, a diversified portfolio built consistently seeking quality and valuation will always deliver superior results, with winners higher and more often than losers. The big risk of total loss associated with equities (on a diversified portfolio built with quality and valuation in mind) is quite rare, and more fear-based than fact-based. Furthermore, the risk associated with a falling stock price, especially when the underlying business remains strong, is more related to investor action than pure loss. In other words, the greatest risk of a falling stock price is how the investor reacts to it.
You don’t lose one cent until you sell. There will be bear markets, recessions, negative market sentiment. Separate the erratic moods of Mr. Market from the financial health of each business. Hence investing is for long term, you need time to find out how management will react and adapt to continue growing earnings and cash flow. It’s their job to figure it out, not the analysts or yours. Yours is just to allocate capital.
Don’t monitor it daily. Investing in dividend growth stocks makes money while you sleep. Don’t stress over it, give time for fundamentals to reflect on stock price. Any business public or private, derives its value based on the underlying performance that the business generates. These value drivers include, but are not limited to, operating results such as earnings, cash flows, sales (revenues) and dividends. Common sense tells us that the true value of a large multinational business, or any business for that matter, cannot possibly change as quickly or as much as daily price quotations would indicate. Stock prices in the short run can be driven by strong emotions such as fear and greed. The intrinsic value of a business is driven by fundamentals and can be calculated within a reasonable degree of certainty. Once this calculation is made, sound investing decisions can be made and implemented.
Being a value investor is more about discipline than it is about intelligence. We can’t control price fluctuations, but we can control the quality of the companies we purchase. The higher the quality, the more confident I am that the company will bounce back on any price drops.
Successful investing is about managing risk, not avoiding it. No business is capable of generating perfect long-term operating results. Inevitably, there will be a bad year, a bad quarter, or even a few bad years or bad quarters. However, a weak quarter or year does not necessarily imply that a sound business model is no longer valid. Businesses are competitive, economies are cyclical, and good managements respond and adapt. That’s why I wait at least 4 or 5 years of declining earnings and estimates that continue to decline before I decide to sell (what I call “ceasing the partnership with that business”).
Read The Intelligent Investor by Benjamin Graham and Common Stocks and Uncommon Profits by Philip Fisher the annual letters to shareholder from Berkshire Hathaway. Tons of consistent wisdom there, like this quote from 1988 letter: “In any sort of a contest – financial, mental, or physical – it’s an enormous advantage to have opponents who have been taught that it’s useless to even try”. Or this quote from 2014 letter: “Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.”
Most importantly: have fun. Investing is a journey, never a final destination, so enjoy the process while you learn and get better at it. It never ends.
Investing is not timing the market. Therefore, my own personal approach is to not worry about things like a major market correction. Instead, I try to focus on the business I am investing in, what I believe its current intrinsic value is, and most importantly what I expect future intrinsic value to become. Therefore, when investing, I don’t focus on attempting to speculate or guess on what short-term price action might or might not do. When I evaluate equities, I am investing in the underlying business and not an unreliable view of what the price might do, especially over the short run. Each business is evaluated individually, so there is zero consideration on how it might correlate to other business or to the collection of all companies that are part of the index. Every market, whether it is a bull market, or a bear market, will always contain overvalued, fairly valued and undervalued individual stocks within the universe. Undervalued companies trade below their intrinsic value. These are companies that have not been getting much love from the market lately, with lots of bad news from the media, in spite of good operating results. To me, these companies present a nice investment opportunity. Therefore, the superior return from a good investment should come from buying good companies at a sound valuation – not from being successful at timing the market to trying to fish the bottom.
Successful investing is not about just being lucky. We don’t need to be good stock pickers. We only need to be able to recognize good companies, companies that are financially sound and buy them when they appear to be selling at a decent value, and then slowly add to them over time whenever those valuations reappear. As an individual investor, it’s our job to calculate the intrinsic value of the business and calculate what the potential return will be based on all information / facts (not opinions) are available today. However, since this exercise is about determining future valuation, there’s a forecast component. Investing always requires a future forecast. However, we must always realize that forecasting and or making estimates are always made regarding what is unknown to us. In time, the answers will become clear because they will become known. In this regard, all investing does require certain leaps of faith. That leap of faith should be a rational optimism. Any serious student of financial history would recognize and acknowledge that economically speaking, things are good much more often than they are bad. In the general sense, common stocks have risen far more often than they have fallen. That is not to say that bad times never come, because they most assuredly do. However, even during bad times optimism has served investors better than pessimism. The rational optimist recognizes that bad times are only temporary, and better times are sure to follow. It’s management’s job to figure out how to adapt and react during challenging times (our job is just to deploy capital to invest), so if we trusted management in first place when we bought a piece of their business, we should trust that they will emerge stronger – as history has shown accordingly. Winston Churchill said it best: “A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” However, forecasting the future should not be a mere guess either. We should attempt to gather all the facts that we can, draw our conclusions based on those facts, and then continuously monitor future results as they unfold. Rational optimism is supported by analysis based on an intelligent assessment of the facts. Even more importantly, rational optimists conduct continuous monitoring and evaluation of their past behaviors and decisions in order to learn as much as they can from the past. So don’t let the unknown future and its difficulties to impair your investing decisions, be it to not take advantage of a buy opportunity, or worse, sell when a business is trading below its intrinsic value.
Investing is not gambling. Gambling is a pure game of chance where the odds are against you and for the house, but you take it anyway for the chance of gain. Investing is the art of practicing due diligence and reason to place money where it is most likely to grow. The future is unknown so some placements will win and some will lose, but the investor can place the overall odds in their favor through their own analysis. People who call investing gambling are simply people who either cannot or do not want to perform their own due diligence. And if someone thinks that doing due diligence is a guarantee they won’t have a short term paper loss next year then they have not been doing this for long enough to actually understand investing. Some mistakes (bad outcomes) are inevitable, but some are avoidable. Diversification and due diligence to quality and valuation are 3 practices that, like counting cards, help the player immensely in terms of tilting odds in the player’s favor. They do not guarantee good outcomes, but they greatly increase the probability of good outcomes.
By focusing on the business and its long term goals, a lot of the distractions above are removed. As Warren Buffett said once, “Investors would do a lot better if they just thought of stocks as being pieces of businesses, instead of tickers with daily price change”.
The objective of this strategy is focused on dividend growth, so that I can live off the perpetual growing income without harvesting the principal. Dividends allow me to remain fully invested in equities at all times, regardless of recessions or approaching retirement, and be exposed to the operating performance of the businesses that are part of my portfolio.
Since the focus is long term, my approach is to find a high-quality and attractively valued business, so that I can partner with that business for many years to come – ideally, forever.
This approach helps to maintain the proper temperament when the market (and therefore, the stocks behind the business) fluctuates irrationally, diverging from the strong fundamentals earlier assessed. Dividends will keep coming and growing, and this cash will be used to partner with another high-quality and attractively valued business, or add more of an existing business already invested in.
The income from the portfolio will grow to a point that I could live off that amount, knowing that it will continue to grow to at least keep up with inflation / adjusted cost of living. This would allow me to retire while being 100% invested in equities, to continue generating perpetual growing income.
My main objective is to never sell, including during retirement. Being invested 100% into these quality businesses that keep growing my annual income allows me to not worry about a crash or recession when close to retirement, because the dividends will keep coming and growing (and I explain how I do the proper due-diligence for that). Since the idea is to have a partnership with these businesses forever, I would only sell as per specific criteria, to avoid any emotions impairing a sound decision.
Every day that we receive a dividend is another reminder of the viability and predictability of this type of income stream. Every time a company pays us to own their stock is a reinforcement of our original decision to buy that share. Dividends paid by solid companies with long histories of increasing them are the predictable foundation upon which a retiree and near-retiree can build a comfortable and secure retirement.
Many people consider stocks risky during retirement, and they prefer a large exposure to bonds during that time, but I strongly disagree. First, as George Schneider once said, “If we can maintain discipline to shut out external world event noise and stick to our plan of growing the income stream, no amount of external events will impact our income component. If we allow ourselves to let in just a portion of the noise and be on the lookout for opportunities that pop up, we can profit from these opportunities by buying on the dips and corrections as we’ve done and demonstrated here. We need to filter out extraneous cues and simply profit from all the confusion around us”.
A strategy based on growing income by dividends help to ride out the crashes, since no principal is withdrawn. Dividend are increased at a rater greater than inflation. That provides perpetual steady predictable income, as long as one track companies earnings in their portfolio. No need for bonds.
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My goal is also to show that anyone can learn and benefit from what I’ve been documenting so far.
All purchases have been documented in the Blog, which has been kept up to date as I do additional purchases, besides posting articles related to this topic. See the “Transaction Updates” tab for details on how the first purchases were made. The current holdings are kept up to date on the Investing Performance spreadsheet.
I don’t look at the overall market but rather individual, high quality, attractively valued businesses. My own personal approach is to not worry about things like a major market correction. Instead, I try to focus on the business I am investing in, what I believe its current intrinsic value is, and most importantly what I expect future intrinsic value to become.
My approach to quality is based on the fundamentals of the business that I’m analyzing, how it did through recessions and crisis, how robust earnings, cash flow and dividends have been, how they’ve been expanding and improving efficiencies, how quickly can management react and adapt, what fundamental metrics look like (balance sheet, income statement, liquidity, margin, credit rating, etc), what their letters to shareholder and annual reports say, and how did the last earnings call or two went. Note that stock price is not taken into account when evaluating quality of the business. It’s all about how the business did in the past (as we can learn a lot from it), how it’s currently doing and what it is expected to do in the future, based on corporate guidance and consensus estimate from the firms covering this stock.
When considering earnings future growth, it’s important to understand if the street understands the business well (estimates are always aligned) or if the company constantly has surprises, which would indicate that corporate guidance and street consensus help little. We should attempt to gather all the facts that we can, draw our conclusions based on those facts, and then continuously monitor future results as they unfold.
As I posted earlier successful investing is about managing risk, not avoiding it. No business is capable of generating perfect long-term operating results. Inevitably, there will be a bad year, a bad quarter, or even a few bad years or bad quarters. However, a weak quarter or year does not necessarily imply that a sound business model is no longer valid. Businesses are competitive, economies are cyclical, and good managements respond and adapt. That’s why I wait at least 5 years of declining earnings and estimates of continuing declining before I decide to sell. It’s paramount to make a rational decision if we want to determine that a business no longer have the quality that we understood previously.
“The secret is to distinguish between a temporary interruption in the business operations versus a permanent impairment of capital.” Marty Whitman
We can’t control price fluctuations, but we can control the quality of the companies we purchase. The higher the quality, the more confident I am that the company will bounce back on any price drops. That’s why temperament is key when approaching investments.
Finding a good quality business is just half of the puzzle. The other half is valuation, because a great business can be a terrible investment if one pays too much for it.
This is the process that I use to find the candidates for my watchlist and how I determine valuation:
I first plot 10-year period of earnings of a company to determine their earnings growth rate. I only consider companies with positive earnings growth rate for that period. Depending on the rate, to determine fair valuation, I either use Graham’s formula (when earnings growth rate < 5%) or an extrapolation of Graham and Lynch (when earnings growth is between 5% and 15%) or Lynch’s formula (when earnings growth rate > 15%).
The extrapolation uses normalized (historical) P/E rate for fair valuation.
Then I look to estimated earnings, by checking market consensus from different analysts + corporate guidance from last earnings results and last annual reports. That will give an idea of the approximate estimated earnings growth. Then I compare that rate with the past 15, 10 and 5-years growth rate, to see if the estimated growth is in line with the past growth. Unless big changes were done recently or are underway, I consider the worst case scenario by overriding the estimated earnings growth with the earnings growth rate from the last 5 years. Then I plot that estimated growth with the fair P/E from step 1, to find out the growth estimated for next 1, 2 and 3 years from now.
That would determine what is a good price to buy it. Then, to do the final check that this company still has solid fundamentals, I check the historical and current data from balance sheet, income statements, profit margins, roa, roe, roi, liquidity ratios, price to book and to sale, payout ratio and shares buyback. As long as it matches reasonable levels and in line with past history, it looks good to me. I plot data for these indicators for the last 5 and 10 years.
This whole process is done fairly quickly if you know what to look for and have the right tools that can pull that information handy. However, it can be very time-consuming if one doesn’t have the proper tools. So many people don’t bother doing it, but I find the 3 steps above critical for success – at least risk is mitigated as best as I can. I use portfolio123 to screen and check some data and FAST Graphs to plot earnings and fundamentals.
For income trusts / REITs / pipelines, I use the same process as above, but I plot Funds From Operations (FFO) instead of operating earnings, I calculate valuation using P/FFO instead of P/E.
For banks / financial institutions:
“The analysis to calculate the intrinsical value of a bank is very complex. Unlike most typical corporations, banks do not produce products or services that they sell to the public. Instead, banks essentially use other people’s money to make their money. When analyzing a typical balance sheet, it’s all about analyzing assets versus liabilities. For most companies, debt represents an important and significant liability. However, with banks, debt is actually the raw material, which the bank utilizes to create its product (typically loans). In other words, much of the debt on a bank’s balance sheet is equivalent to the product inventory on a typical company’s balance sheet. Unfortunately, this is not as straightforward as it is for a company that produces something. A bank’s balance sheet contains very complex provisions for loan losses, trading portfolios, investments, etc.
The asset side of a bank’s balance sheet is also very different. With banks, their assets are anything that they can sell for value. Most banks do own hard assets such as buildings and real estate; however, these hard assets typically represent a very small portion of the asset side of the balance sheet.
Loans are generally the major asset of banks. However, there are various categories of loans, and subsequently loans carry significantly different levels of risk to the bank.
To learn more about analyzing the value of a bank, check this article by Chandan Dubey on the financial website Guru Focus titled “Valuing a Bank Made Simple: The Balance Sheet.”
When investing, the 2 main fundamental metrics to evaluate banks are Common Equities per Share or book value and Return on Equity (ROE). More info about that is on the paper titled “Valuing Financial Service Firms” by Aswath Damordaran published on April 2009.”
Lastly, it’s paramount to notice that lower valuation are not always an opportunity to acquire more shares. We must do our due-diligence to validate that shares are not being priced lower because they deserve to be lower. In other words, when buying more shares, we must do every effort to determine that the business is not a value trap. For me to consider a company a value trap, I have to believe that there is a permanent long-term deterioration in the future fundamental strength and health of the company. To me, a company becomes a value trap when either it’s on the verge of going out of business, or poised for a long protracted period of collapsing or even disappearing earnings, cash flows, and inevitably dividend cuts or elimination.
The best value opportunity manifests when earnings, cash flows and dividends continue to grow or improve in spite of current price weakness. It is for these reasons that I believe in focusing on fundamentals first and foremost, with the primary objective of evaluating a company’s intrinsic value. Once this is accomplished, and only when it is accomplished, will I even consider bringing price into the analysis. When I am confident that the current stock price is lower than my assessment of intrinsic value, I see opportunity, not a trap.
Here is an example of how I do my research when evaluating a business, to determine if it meets my quality criteria.
Here is an example of how I calculate valuation and the importance of buying a business when fairly valued.
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My goal is toward stability, predictability and reliability of growing income. The primary determinant of high quality is superior financial strength. Financially strong companies possess the staying power and resources to weather the occasional bad storms that will inevitably occur. Every business will on occasion face challenges and difficulties. Meeting those challenges requires a strong balance sheet and an adaptive and competent management team to guide the company across troubled waters.
The primary determinant of high quality is superior financial strength. Financially strong companies possess the staying power and resources to weather the occasional bad storms that will inevitably occur. Every business will on occasion face challenges and difficulties. Meeting those challenges requires a strong balance sheet and an adaptive and competent management team to guide the company across troubled waters. No business is capable of generating perfect long-term operating results. Inevitably, there will be a bad year, a bad quarter, or even a few bad years or bad quarters. However, a weak quarter or year does not necessarily imply that a sound business model is no longer valid. Businesses are competitive, economies are cyclical, and good managements respond and adapt. That’s why I wait at least 4 or 5 years of declining earnings and estimates of continuing declining before I decide to sell. That’s usually the length of a business cycle, and if a business cannot turn around during a full business cycle, then I rather deploy my capital somewhere else, with a business that can provide the fundamentals of meeting my goals, which is oriented towards safety, income, and consistency.
Another factor that would cause me to cease the partnership with the business would be cutting or suspending dividends. That’s a sign that the business is either struggling with cash flow to sustain the dividends, or it’s struggling with growing revenues, and therefore, it needs to free up extra cash for potential acquisition / merges, or any transformation to revive the business. The sole reason I have a partnership with these companies is to provide a growing stream of income, so if they fail to deliver that income, they no longer meet my goals.
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The initial purchases for Utilities sector can be seen here.
The initial purchases for Energy sector can be seen here.
The initial purchases for Industrial sector can be seen here
The initial purchases for Telecom sector can be seen here.
The initial purchases for Financial sector can be seen here.
The initial purchases for Materials sector can be seen here.
The initial purchases for Information Technology sector can be seen here.
The initial purchases for Consumer Discretionary sector can be seen here.
The initial purchases for REITs can be seen here.
The initial purchases for Consumer Staples can be seen here.
There were little activities until 2017 since the focus was on the methodology and discussion of the businesses in the portfolio.
Starting in 2017, I’ll post monthly updates on my purchases through funds that come from money that I save + dividends from companies I’m already invested on, for both Canadian and US portfolios.
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