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Dividend Growth Investing

Everything about my long term strategy to replace income, by living off the perpetual growing dividends.

 

The objective of this strategy is focused on dividend growth, so that I can live off the perpetual growing income without harvesting the principal.

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.

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I’ve been investing for almost 20 years, so the idea is to demonstrate how I would invest if I had to start all over again.  How I identify quality companies, how I calculate valuation, how to make decisions to sell it sometimes or wait to buy my “first” position or add more. This is the investing portfolio being tracked on this website.

The first purchases were posted on the Red Flag Deal’s Investing Forum, which also contains lots of discussions and ideas about the concepts and techniques for the temperament required – so please read those posts when you have a moment.

 

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.

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. 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.

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.

“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. On my case, I have a mix of long term investing strategy based on dividend growth with short term investing strategies based on algorithmic trading models.

 

This is the session to determine what to buy and when to buy 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.”

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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Selling is one of the hardest decision to make, much harder than buying.  To me, selling an investment means no longer having a partnership with that business.  The reason behind such decision must be rational – therefore, emotions such as fear (due to price movement or uncertainty in the economy) or greed (liquidating a stable business to raise capital for another business that might be “popular”) cannot play a role in this decision. I must certify, via a rational criteria, that the business that I’ve been partner with no longer meet my goals, or that fundamentals have been deteriorating (or deteriorated) to a point that there is more risk waiting it to turn around than locking these losses and moving on to the next opportunity.

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 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.

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In order to simulate how I would build a portfolio from scratch, the first purchases were documented below.  The Canadian DGI portfolio was built first.

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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