Saturday, May 4, 2013

Learning From Mistakes

Major mistakes I've made and what I've learned.

●Chasing Yield:
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?


  1. Luckily I've never given in to the chasing yield aspect yet, but I've made my share of mistakes. Like you I pretty much know nothing about TA and I wouldn't base any purchase solely off of TA even if I was an expert. I would be interested in learning some of the basic TA methods though because there's been times where I'm sure I could have gotten better purchase prices had I looked a bit at the charts.

    I think it's easy to become overconfident in a potential investment when you dig deep into the numbers. But you bring up a great point about looking at a potential investments on a qualitative basis going forward.

    And thanks for linking. It was a great series to write up because I haven't really found too many sources that cover different valuation methods, and certainly not compiled in one place. I've been seeing a lot more comments in the blogosphere talking about how they're just starting with DGI and I felt that there was a need to help out those that are just learning.

    1. Also, I think it's very important to analyze your investments after the fact to see if it still fits your goal. Making a mistake is fine and to be expected, but you need to learn something from it. Sometimes there's going to be issues that you just couldn't have seen, but the majority of the time it's something that you missed. It's a learning moment, but it's up to everyone of us to take advantage of that.

    2. Thanks for the comments. Yes I've noticed a number of new bloggers too. It's interesting to see what they buy because the stalwarts are not attractive like they were when we started. PEP 21 p/e, MCD 19, KO 22, JNJ 23. Even old PM has crept up to 18.

      Oh I assure you I've bought some silly companies before I figured out exactly what I wanted to do. I think my first dividend growth purchase was UVV which I later sold. Honestely when I first started I would only consider companies with at least a 5% yield. AT&T was another early-ish buy, but I still like it. I bought RPM on the cheap and later sold because the price went up! Dumb reason to sell. I didn't determine it to be overvalued or even know how to do it. Basing sell decisions solely on price is silly.

      Anyways I am continually learning. While I think I was pretty silly 3 years ago, I bet I'll think of the 2013 version of myself as silly 5 years in the future.

  2. Oh yes stocks with very high yields never really seem to work out. Theirs a simple answer to the desire to pursue stocks with very high yield. Very high would be north of 7%. Just remember dividend yields tend to follow credit quality. So a stock yielding 10% quarterly dividend most likely has a junk bond like credit rating.