Major mistakes I've made and what I've learned.
An income investor, such as myself, buys assets (stocks & bonds) with the intent of building a passive income stream. So the higher the yield the better right? Not always. Focusing solely on yield is a recipe for disaster. It's just a matter of time. Ask any PBI, FTR, EXC, CLF, or TEF investor how the dividends turned out. All of these companies cut dividends significantly within the past few years in case you haven't heard of them.
So what were the warning signs? High yield!!! Yep. When you see a stock yielding 10%, you have to ask yourself why. Why was PBI yielding 10%? Why weren't people snatching up shares boosting the stock price which brings the yield back down. Hint: The yields were high because the market expected a dividend cut. That lowers the price, but increases the yield until the cut actually happens. So when I see a stock with a yield that seems too good to be true, caution and extra research is in order. Please note that some industries (MLPs and REITs) are built for high yield. Seeing an MLP with a yield of 7% is not a cause for concern. Seeing an utility with a 7% yield definitely is.
Other than high yield itself, I look for frozen dividends or dividend growth increasing at a pace well below inflation. Some other things to look for are cash flows and the debt load. If debt becomes too high, some companies (AVP) cut the dividend to relieve pressure.
An example of me chasing yield before I fully solidified my strategy:
Ok it is true that I have made money with Boardwalk. Pretty much only because it yields 7%. On the surface my BWP purchase 20DEC2010 doesn't look so bad. But what did I pass up? On that very same day I could have bought MCD @ $76.92, KO @ $32.66, PM @ $59.57, or LO @ $27.36! The opportunity costs were high! Whoops!
I already reduced my BWP stake and might do another round of sales if the distribution doesn't increase within the next 6-12 months. The value investor in me compelled me to hold on to the rest of this stake. I feel this company is currently at fair value.
Going forward I'm more interested in quality and dividend growth than rolling the dice with high yield. I may let the high yielders I already own ride if I feel future prospects are positive.
●Basing Purchases Solely on Numbers:
Running a screen or using some 10x10 chart off seeking alpha is not a good enough reason to make a purchase. Numbers aren't everything; investing is as much an art as it is a science. Usually when I run I screen, it will be chocked full of a bunch of companies I've never heard of. We're talking small caps, ADRs, foreign pink sheet stocks, and everything in between. Stock screens are a great place to look for ideas and helps to cut down on research. I need to look at more than just numbers. What is the story? What do they sell? Can I understand what they do? Do I think they'll be in business 20 years from now? What is the growth plan? Can they still sell products/services in a recession? A depression? How has the business performed historically? Does management make sense on conference calls? Is management confident? Is management committed to the dividend?
I ask myself questions like this. If I cannot answer these types of basic questions, I either need to dig deeper or start looking at something else. A 10x10 chart does not give me a clear picture. Period.
Investors who just look at numbers are forgetting that JNJ is not only a ticker symbol, it is a business.
●Basing Purchases off Price Charts and Graphs:
I don't use technical analysis at all anymore. I am a long term buy and hold investor, short term price trends do not matter to me. TA would give me short term answers to long term problems. It doesn't mesh. I don't need to buy at the lowest possible price, I just want to be close! Instead of looking at charts and graphs, I spend time actually valuing the business! That's how I determine when to buy. Becoming proficient with DDM, DCF, and other valuation techniques really is a great way to figure out buy prices. Man, I'll tell you it gives me so much more confidence than a stock chart ever could. After I figure out buy prices I like to fact check with a comparison to FAST graphs or Morningstar.
Passive Income Pursuit has been kind enough to post a series of articles on valuing stocks. I recommend checking out his work. All the information needed to value businesses is free on the internet. Calculators and all.
Remember to periodically redo calculations. EPS and dividends change over time. There is no reason to use my 2011 buy prices, the information is outdated!
Readers: What mistakes have you made? What have you learned?