Money, money, money…
When it comes to investing, I’m a bit of a nerd. I like researching stocks and learning about different investing philosophies. While I like learning about investing, it was MONEY and the rush it provided that first attracted me to it. It feels good to buy a stock and have it make money. This feeling is one of the reasons I think people equate investing in the stock market to gambling. I’m no gambling addict, but I’d wager there are some similarities in the feelings I got when I first started investing to those who gamble.
Resist the urge
While I don’t get as excited as I used to I still get excited and nervous when I buy a stock. I only have to go back to my last purchase of IBM to remind myself of these feelings. What can I say, I like buying stocks! Because I set pretty conservative target buy prices I end up waiting around for stock prices to come down before I’m willing to invest. All this waiting around, tests ones patience. More often than not, I find myself resisting the urge to buy stocks. It’s this resistance or patience that is so important. The ability to do nothing, and just wait… it’s quite hard, but very important. By waiting for a better valuation or a more reasonable price I protect my portfolio and afford myself a certain margin of safety. This also means I may miss out on some opportunities, but I’m OK with that.
Investors can be their own worst enemy, and I’m no different. Psychology plays a large role in investment decisions, and it is a lot harder to think rationally and not over react when you get euphoric feelings after a stock market rally or depressed in a bear market. With this in mind it is important to know yourself so you can mitigate the damage you may inflict on your portfolio. Most know to buy low and sell high, but there are few that actually do on a consistent basis because their emotions become counter-intuitive to their investing plan.
Know yourself & make a plan
An important part of investing is to know yourself. For me this is understanding that I like to buy stocks, so much so that it borders on an addiction. I need to resist this urge and make sure that when I do invest, it is in high quality dividend growth stocks at a good price. This is where an investing plan or a set of guidelines can be very useful. You can take some of the emotion out of investing by setting up an investment plan that details when you should buy or sell a stock. Having to justify you actions on a blog to a bunch of strangers, also helps ;)… Thanks guys!
Related: Why I started this blog
When I invest I try to make sure that I’m investing in stocks with the following characteristics:
- Sustainable competitive advantage (Wide moat stocks):
Morningstar has an “Economic Moat” rating that is quite useful if you are looking to check this quickly. Look for a wide moat rating. Morningstar doesn’t rate all stocks and I’ll still consider ratings below wide, so in these cases I look at the Return on Equity (ROE) and Return on Invested Capital (ROIC). ROE and ROIC are profitability and efficiency ratios that I like to compare to the industry so that I can determine if the company has been able to perform above the industry for a sustained period of time (usually 10 years). I like to look at ROE and ROIC over the past decade and I typically want to see ratios that are above the industry average and have remained steady or increased over time. As a guideline I like to see rates typically higher than 10-12%, although better is higher (around 20% is good). I will stray from these guidelines as these ratios can vary widely from industry to industry. For me it’s more important that the company has a ROE and ROIC above the industry average.
- Long dividend streak of increasing dividends at high growth rates
Typically I like to invest in Canadian companies that have increased their dividend for 5 or more consecutive years. For US companies I look for a streak of 10 or more years. The longer the streak the better. I like to invest in high dividend growth companies, so if they have 5 and 10 year annual average growth rates above 8% this is a good sign. It should be reasonable to expect this high dividend growth to continue into the future.
- Consistent earnings growth
I like companies that make more and more money over time. If I look at the past 10 years I like to see that earnings growth has steadily increased year after year. I am willing to accept some volatility as I recognize that over a decade there may have been a rough patch. That said I don’t like to see a company lose money in any of the years. It’s also important that I think this trend will continue so that dividends can be increased with earnings in a sustainable manner.
- A sustainable dividend (Payout ratio less than 60%)
The payout ratio is the percent of dividends that make up earnings. The lower the better, but I’ll invest in companies with a payout ratio below 60%. This allows the company to grow the dividend and still have money left over for growing the business. 60% is a guideline, and for industries like utilities and telecoms I’ll consider higher payout ratios.
- Strong financial strength
This is a very important characteristic. There are a number of ratios that you can look at, but these vary from industry to industry, so I’ll usually check Valueline to see if their rating for financial strength is a B+ or higher. Standard and Poor (S&P) also has credit ratings, in which case I’ll look for a minimum credit rating of BBB+. If they aren’t rated by Valueline or S&P then I start to look at the debt to equity ratio. Lower is better and you want to have this at least below 1.0. I like to see the current and quick ratios above 1.0 and I want to see that the company can easily pay its interest expense several times over with its earnings. These are just guidelines and depending on the industry it can be quite time consuming to determine the financial strength of the company.
Related: In What Conditions Would I Consider Selling A Stock?, Financial Strength: A Key Element in High Quality Dividend Growth Stocks, How I Use Value Line Reports to Quickly Assess A Dividend Growth Stock, Wide Moat Stocks In The US Dividend Champions List & Can Past Dividend Growth Rates Be Relied Upon To Predict Future Rates?
Even with my guidelines I still find it hard to resist buying stocks. For example I’m currently resisting the urge to buy three stocks. All these stocks are currently (November 13, 2014) below or close to my target buy prices, but because they fail to meet all the criteria, I haven’t pulled the trigger.
1. Ensign Energy Services [ESI Trend]: I’ve been tempted by this stock as it has a long dividend streak; especially for a Canadian company, and its dividend yield has been a lot higher than its historic norms. I’ve been holding off because it doesn’t appear to have a sustainable competitive advantage, its earnings are erratic and earnings growth over the past decade is low. Even after all that, I’m still on the fence, so I’ll be doing a dividend stock analysis shortly to make up my mind. They have a 19 year dividend streak, which is in the top 10 longest for Canadian companies. It’s this dividend streak that keeps pulling me back in. Having a long dividend streak with consistent high dividend growth can be a sign of a well-managed company or a wide moat stock, although certainly not in every case. I think after my dividend stock analysis I may find out that this is a good stock, but not a great stock. I’m also curious to see how much of a dividend increase (if any) they will announce in the next month or so.
2. BHP Billiton PLC [BBL Trend]: The company has a dividend streak of 12 years with decent dividend growth and currently has an enticing dividend yield of over 4.7%. Its earnings growth has been erratic because it’s dependant on commodity prices, but the earnings growth for the past decade has still been high. It’s lack of competitive advantage and erratic earnings have kept me on the sidelines.
3. Glentel [GLN Trend]: This is a small cap Canadian stock with a dividend streak of 7 years and a high dividend yield. I’m concerned about its financial strength, so I haven’t invested in this stock. If it is able to improve its financial strength then I may reconsider it in the future. For now though they have too much debt for my liking. They also breached a bank covenant in their Australian operations which is a bit of warning sign for me. I think Glentel will likely pull through, but I’m not willing to risk my capital unless the company is financially strong. I have some wiggle room with my various investing criteria, but I’m not willing to compromise on financial strength.
It’s important to know yourself and how you’ll react in certain situations so that you don’t let emotions get the best of you. Having an investment plan that sets out clear criteria for when you should buy or sell a stock is an important step in removing emotions from a decision that should be made rationally. Having the patience to do nothing until the right time is an under appreciated investing skill and one that I regularly struggle with. While I struggle with this, my investment plan seems to be working. When I look at the stocks currently in my portfolio: IBM [Trend analysis], Rogers Communications [Trend analysis] and McDonalds [Trend analysis], I’m pleased. So far I’ve managed to stick with my plan of buying high quality dividend growth stocks.
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