Doubling Down On Quality Stocks

We usually use dividend growth stocks as our main vehicle for income generation. The reasons are pretty self-explanatory. Even though the portfolio should be heavily diversified across different sectors and asset classes, at any given time one or more of our positions could go against us. When a position is showing a paper loss, there is both a benefit and a drawback. The drawback is obvious in that there is very little one can do when a position is underwater. In fact, if the respective positions runs quite a distance from the entry-price, it becomes very difficult to sell calls (which we will discuss ) against the long stock especially if volatility is low. Therefore the increasing dividend becomes a huge asset in these types of scenarios because those increasing reimbursements eat away at the original cost price. However the real benefit in these names is the following.

When quality dividend growth stocks get oversold, their yields rise meaningfully. Now our portfolio as already stated is designed to spit out sizable amounts of income every month depending on portfolio size. This income if not totally withdrawn will be looking for a home and quality oversold dividend growth stocks is usually the best destination for these funds. Now one may counter that argument by stating that one should never double down on paper loss losers as it increases portfolio risk (more capital assigned to fewer positions)

This may be true but the best place to “drip” or invest more cash flow is into quality oversold blue chips. Large blue chips usually have their valuations run between certain extremes. So basically their price to sales ratios or price to earnings ratios at times will be at the bottom of their ranges. As long as the respective company’s fundamentals are still sound meaning sustained growth is predicted over the long term, I see no problem in doubling down on a quality stock. However where I would not recommend doubling down would be in stocks that do not have strong competitive advantages or ones which are not diversified as then the risk to the downside really comes into the play. This is an area where investors definitely slip up. There is a big difference between doubling down on a proven strong blue chip over a cheap stock which has no competitive advantage. What do I mean by competitive advantage ?

Does the stock  have economies of scale? Does is have customers for life or high switching costs? What about the distribution network or the brand the company has built up over the past decades? These all tie into a firm’s competitive advantages which is why we want to be in a position to take advantage when a proven dividend growth blue chip is on sale. In fact, as stock market declines usually take place at a faster pace that rallies, you will observe that proven dividend growth stocks don’t sell that cheap very often. In fact most of the time, they sell at a premium because they bring an element of “certainty” to the mind of the investor. This definitely plays into our hands as the cavalry will always come to the rescue to a large extent if the stock gets too oversold at any given time. This set-up acts as a nice tailwind (along with the dividend) that keeps the stock elevated over time.

Remember there is a huge amount of investors that only trade dividend aristocrats or strong dividend growth stocks. They trade all the old reliables like McDonald’s (NYSE:MCD), Coke (NYSE:KO), Walmart (NYSE:WMT), etc. They just wait for them to become overvalued which is why a proven aristocrat at a low valuation usually gets snapped up quite quickly. “Proven” though here is the key word as we always have to be conscious of the downside. Always have in mind that stocks could enter a bear market tomorrow. Are you happy with your portfolio? Would you add to all of your positions? These questions are important when one is building an income orientated portfolio.

 

 

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Long Term Buy And Hold Investing Could Be Dead

Now that we have the income argument out of the way, the next step is to go and look for the vehicle(s) that is going to generate income for us. One cant’t really look past dividend growth stocks as the vehicle as they are tried and tested and have been through the mill so to speak. Many long term investors merely buy some popular names in this category and hold onto them for life. For example companies such as McDonald’s (NYSE:MCD) and Coca Cola (NYSE:KO) have raised their dividends for decades which means investors who are long these names have received a pay rise every year since they started to invest in these stocks. Part of this set-up – I agree with. Long term dividend growth investing really gets compound interest working for you. In fact, dividend growth stocks with reasonable yields usually result in the investor doubling his income in eight years as long as all dividends were re-invested back into the respective stocks.

The benefit here is that quarterly dividends can be pumped back into the stock at lower prices which means the investor over time can average out the buying price. In the industry this is called “cost basis reduction” because every re-invested dividend brings down the original cost of the original shares over time. This improves one’s probability of success especially in an up-trending market. However the pretence with dividend growth investing is again predominantly investing for the future. Yes the investor could just live off the dividends and not touch the stock but in this day and age, I’m afraid (income-wise), that yield just won’t cut it for many investors looking for robust monthly income unless of course one is open to more risk.

For example a $100k portfolio made up of popular safe blue chips yields around 3 to 4% and the average yield goes up by 6 to 8% per year. So based off that original capital, the investor would collect around $3,500 a year and would receive a $250+ increase on his or her income after the first year. Those numbers are simply not going to cut it for many income investors. Our philosophy is slightly different in the sense that our portfolio will not have to hold stocks for life. In fact, I believe this is one of the downfalls of the dividend growth method. For the life of me, I do not understand why an investor does not sell a stock when it gets overvalued. When a stock is selling above its average earnings and sales multiples, the odds are high that upside movement in the stock (if any) from that point will be muted. Using dividend growth stocks as the vehicle is fine but the trick is not to get married with them.

Better to use them for income purposes like numbers on a page. Therefore as you read this, if you have any prejudices towards some stocks, I would invite you to get rid of them now. You do not need to hold a stock forever even if you absolutely love the returns it has produced over the past few decades. This is the lure of the “Dividend Aristocrats” which are a group of companies which have raised their dividends for 25 years+. However because of their track records, many of these companies sell at a premium which is why many of them (especially now with stocks at all time highs – 27-01-2017) are so expensive at present and should be avoided for income purposes. Past performance is not always an indication how the future will play out. Over the last 4 decades at least, the world has witnessed huge gains in many asset classes such as stocks, bonds and real estate. However the next few decades could be entirely difficult especially with government debt nowadays being much more elevated compared to previous times.

The reason why it is dangerous to get “attached “ or “married” to stocks is because of the mindset it fosters. For example if an investor times a stock purchase well and sees significant returns over time, it is very difficult for this particular investor to change strategies over time. It is something similar to going to Vegas and winning all around you on your first day. You believe you are a King and nothing can phase you due to you having something magical or different within your arsenal. You find out the hard way that it wasn’t your strategy at all but probably only luck that caused that big pay day on your first innings. Just remember this. Holding stocks indefinitely usually means that you are waiting for some reward in the future. Past performance is not always a guide to future returns. In fact if a stock has had a huge run-up over the past few decades, it probably is not a good long term hold at present as it has become over-valued. To comprehensively use the income strategies outlined in this book, there is going to be a level of active management involved. I’m not saying there isn’t a place for “stock pickers” who can choose undervalued companies, hold them for a while and then sell them for a profit. Yes there is but those strategies takes a person out of the “now” and hence focuses more on the future. If we have capital to invest, we want to make a return on that capital as quickly as possible – something similar to putting money into a bank account and earning interest.

In fact even within this bull run in equities for multiple decades now, stocks have still had under-performing periods. For example, look at the performance of stocks from the year 2000 over the first decade of this century. As the chart illustrates below, price in the index didn’t come back to original levels until 2013 – a full 13 years later! However throughout this period, one could have used many strategies to increase their income but there is very little one can do when a position remains underwater. Yes one can re-invest dividends until the respective position comes back into the black. However if equities suddenly entered a bear market, you would be left holding the bag and would have to wait potentially years for your position to come back into the black. We certainly do not want a situation like this so we protect ourselves by being highly diversified and by ensuring positions sizes are in line. No one position will ever make or break us which ensures we are always focused on income and not pie in the sky opportunities.

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For example, if an income investor went all in with a popular dividend aristocrat such as Walmart (NYSE:WMT) in the year 2000, here is how the position would have played out over the 13 year duration. Walmart rose aggressively along with the stock market in the nineties but actually topped out just before the turn of the century. Let’s say for arguments sake that an investor bought $20,000 worth of stock on the 2nd of January in the year 2000. That capital sum would have turned into $23,664 in January 2013 if every dividend was invested back into the company. This turned out to be an annualized return of 1.3% – a return investors would not have been happy with.

I acknowledge that Walmart’s dividend growth rates have not been as robust as other dividend growth stocks but as the chart shows – this stock went nowhere for the best part of a decade. When this happens to an income portfolio, the investor in question is depending wholly on dividend growth rates to get the original investment back into the green. The take-away is this. Every time you pull the trigger on an investment, consider the following statement.

“When you do the right thing at the wrong time – you get pain”

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Investing in a safe dividend aristocrat is never in a sense the wrong thing to do. However buying at the top of the market when the stock was over-valued definitely made it the “wrong time” to invest. Now you may counter and say that if the investment is for the long term – can one not ride the downturn out? I would answer yes but the kicker is that one’s returns will be dismal compared to original expectations. However what is even more important than that is that it is much more advantageous to have as little positions as possible underwater at any given time. Why? Because then the possibility of trading in and around them becomes non-existent and income suffers as a result. In fact, at any given time, investors need to accept that selling some positions (as long as a profit is made) will become the new age of investing. Remember we are focusing on the here and now. We want profits and income today. If a stock runs away from us and we see we could have made more. So be it. We move on, we search for our next vehicle. Rinse, wash, repeat..

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Focus On Income Predominantly In The Stock Market

“Fear & Greed”. These are the two emotions that primarily exist in the stock market (NYSE:SPX). However if you really think about it, these two emotions can be eradicated if one adopts an income mindset instead of a capital gains mindset. Fear is present when you one of your positions is tanking at a rate of knots. The position may be profitable but is loosing paper profits every day. You become fearful and eventually sell. On the other hand greed occurs when one of you positions may have rallied hard and you want more. Maybe you even take out some form of leverage to fund your purchase. Unfortunately the house of cards comes tumbling down in the aftermath when you come to the realization that you bought at the top of the market or cycle and to add insult to injury – with leverage.

This whole nonsense can be done away with by adopting an income mindset. However I must say that only the minority will be able to adopt this mindset. Why? Because the stock market and its associated commentary will do its very best to lure you into its false sense of security. In fact, it is so easy to change one’s game plan in the markets when so much commentary on stocks is right in front of you on a daily basis. Articles on stocks going to the moon are not only there for click-bait reasons but also to lure you back into the markets at a moments notice. Furthermore many of these articles are written by professional finance writers and on the surface look really slick.

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However here is the critical issue. All of them bar none focus on timing and that is the key word. The articles are usually based off improving fundamentals or improving financials in a stock and you become worried or “fearful” that you could miss out on a move. What happens as a result? One’s portfolio gets dragged from pillar to post as it always chooses the perceived best stock at a given point in time. This strategy long term is set up for disaster as one’s emotions are heavily involved due to trying to time the market. Our portfolio does things differently. We are going to call the shots and not be at the behest of the market at any given moment.

The first crucial step one can do before getting their feet wet in the market is to lay out a plan with their end objectives in mind. Having a clearly laid out plan as well as being income orientated is how to become laser focused on your goals. In fact, your brain is a servo-mechanism which means it will deliver the goods for you (and change….) if you program it properly. Since our premium portfolio will be income based, the first question you need to ask yourself is how much income do you want? This may sound strange but it absolutely crucial.

The end goal here is money, or cash flow would be a better way to coin it. You need to decide right now how much cash flow do you require every month and in what time frame – 3 years from now?, 10 years from now?, etc. These are the steps that many investors don’t take initially when they start out investing. They blindly go long some stocks and index funds and take a “see how they will do” attitude which is far too general and risky. I’ll say it again if it hasn’t sunk home yet. The reason to invest is for cash flow or money, period. It is not to have your shares stacked away in a portfolio for ages as you wait for your ship to come in. No we want to work on our income goals straight away.

We want to structure a portfolio where cash flow is king. We are not interested in speculative capital gains. If you can get this mindset down pat, you are most of the way there. For example, in the great recession of 08 and 09, most of the investors and speculators that went to the wall were primarily invested for capital gain. At the top of the market (2007), investors piled into both real estate markets and stock markets and many of them got wiped out in the process. You can see the sentiment chart below where emotions ran extremely high at the height of the boom as investors believed markets were going to the moon and they were going to get rich in the process.

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Source : Sentimentrader.com

This brings me to another important lesson in investing. If you do the opposite of what the crowd is doing at any given moment, you are giving yourself the best chance for for success in a big way. For example, we will not be buying stocks for our portfolio when everyone else is buying. Our aim to be buying quality stocks for as cheap as possible. Our portfolio will be heavily diversified so one position along will not be able to hurt us. Let’s revert back to the great recession though as there were powerful lessons to be understood there. Income derived investors that had solid diversified portfolios didn’t lose any sleep. Remember the value (in terms of $ amounts) of the portfolio was secondary to the income being produced by the portfolio. In fact, astute investors used the steep decline in equities to buy more quality stocks at really attractive dividend yields. The same could have been said about the real estate market. Investors who focused on positive cash flow came through the great recession unscathed as the price of their assets was secondary to the yield the real estate was giving them. On the contrary, investors who needed capital gain appreciation (usually speculators or “flippers”) got wiped out when investors ran for the doors.

So make the decision today – the decision to be primarily a cash flow or income investor. It may not be the “sexier” choice but believe me it is by far the most predictable strategy when looking for long term gains in the stock market. Investing for income should definitely form the lions share of portfolios, especially investors who do not have meaningful savings or a pension as it involves far less risk and is far more predictable over the long term. The advantage of income is that it forces you to looks for returns now, not in months or years from now like in other types of portfolios. We want to be always focusing on the present (yes right now – as you are reading this blog post) as now is the only time you will ever have.  Therefore shouldn’t we make “now” the most important and productive time ever?

I believe we should but remember that the whole stock market industry wants to take you away from the “now”. They want to sell you on the next and best thing that will generate huge returns for you in the “future”. Nope that’s not us. We want results now. We are not dreamers. We are action takers who will not be swayed by consensus or opinion. If you are still with me, let’s get this show on the road..

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Stocks & Gold About To Trade Inversely?

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Will Bond Outflows End Up In Commodities ?

The CRB index ($CRB) looks like it is about to break out to new highs. The rally has been primarily driven by the rally in crude (NYSE:USO)

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Amazon (Long Term) Still Undervalued

12-12-16

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Caution & Patience Required At Present (S&P500)

With equities at all-time highs in the US and sentiment reaching ultra optimistic extremes, I think it’s a good time for investors to reflect on 2016 and turn to their goals and objectives for 2017. In the premium portfolio we run, we have being very wary about investing in equities for the past month to six weeks now. In saying this, the Trump effect definitely didn’t have the bearish effect on the markets that many thought it would have had. In fact the US dollar has gone from strength to strength and the S&P500 (NYSE:SPX) has taken out its former highs which should be reason enough that investors simply can’t short the US at present.

The longer investors remain bullish about the market, the more likely the market will suffer a deep correction. When “everyone is one one side of the boat” is when things will start to unravel but we are not quite there yet.

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Source : Sentimentrader.com

The one outlier here is the bond market which definitely is responding to rising inflation and I just do not see this trend abating anytime soon. Rising inflation and rising interest rates over time will decrease the amount of money in circulation as more capital will have to be put to use in order to meet loans on mortgages and on cars, etc. Despite all the bullish comments you hear about the US Dollar and the US economy being the strongest in the world at present, rising inflation is a symptom of currency weakness and not currency strength. Therefore my personal view is that sooner or later, US equity markets will once again enter a bear market. Will our newsletter’s subscribers miss some of the potential upside side still in equities? Probably yes. However protecting the downside has always being our number one priority and always comes before upside potential

Therefore the only scenario where we would be getting long here would be with stocks with compelling competitive advantages. Furthermore these stocks would have to be recession-proof which basically means that their earnings and their share price would have to have a history of not being adversely affected during steep downturns. Moreover these stocks would have to be increasing their dividend at a healthy clip every year. They would also need to have a strong balance sheet (Just as good earnings, cash and debt levels prior to the last big downturn). If the next daily cycle low in the S&P500 is deep enough to really reset sentiment, then we may initiate some positions in some real quality undervalued Blue Chip stocks. Quality is a huge requisite here especially with equities trading at all-time highs.

However the harder equities keep rallying, the more we will lighten up on our equity positions over time. Remember that equities in the US bottomed on the 6th of March in 2009 which means we are now almost eight years into this long bull run. The higher we go, the more likely capital will start to seep out of equities and into other asset classes. This is where the big money will be made over the next decade. The investors who first ascertain which asset classes will undergo a bull run and secondly pick the best stocks within those asset classes will be the ones who make a fortune over the next decade

 

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