Many investors believe that once they find the perfect dividend stock, they can just buy it, and kick back and collect the dividends for eternity. Unfortunately, even if you identified the perfect dividend growth stock, you can still lose money. This is because identifying and selecting an amazing stock, with amazing prospects, and attractive valuation is just part of the formula for investment success. The next part is the psychological traps that could cause you to do silly things.
The first reason why investors lose money is because they focus on stock quotations as a source of the value of a stock, rather than looking at fundamentals, and then determining whether the stock has much value. This could cause them to do silly things, such as selling during a bear market in order to avoid more losses.
For example, if the stock price falls significantly, but fundamentals are fine, individual investors might sell in panic and lose money. For example, Coca-Cola (KO) was trading at $30.68 at the end of 2007, paid 76 cents per share in annual dividends and earned $1.29 that year. By the end of 2008 however, this otherwise great business could have been acquired at $22.63. The fundamentals were still great, but if our investor panicked and sold out, they would have lost out. This investor would have not only missed out on dividend increases for the next five years, but also missed out on the potential for earnings and dividend raises for the next several decades after that.
The second reason why investors lose money is because they get emotionally attached to stocks they have owned, and do not have a clear exit plan, which would protect them. I have noticed that many investors tend to sell after a quick gain, but if things go south, they start rationalizing their actions and might hold on for too long. An example of holding on too long is if fundamentals deteriorate and companies cut or eliminate distributions.
An example of that include shareholders who held on to Eastman Kodak (EK), Citigroup (C) and Washington Mutual (WM) after the companies cut or eliminated dividends, hoping for a revival, which of course never happened. In the case of Coca-Cola, if they had cut dividends in 2008, I would have sold out without even thinking about it. If the company survived however, I would have considered buying it again, provided it met my entry criteria.
Investors who purchase dividend stocks that subsequently cut dividends might want to reevaluate and sell. Statistically speaking, dividend cutters and eliminators have severely underperformed over the past 40 yrs. Investors would rationalize holding on to dividend cutters and remain hopeful, when they should have cut their losses and purchased the next dividend idea. For example, Frontier Communications (FTR) paid 25 cents share every quarter in 2004. By 2010, the dividend was cut to 18.75 cents/share, followed by another cut to 10 cents per share in 2012.
Investors in Frontier who are still holding on, hoping for a miracle, despite the fact that they have been burned twice might not be following the most optimal strategy for their dollars.
In hindsight, buying General Electric (GE) or Wells Fargo (WFC) right after their dividend cuts in 2009 would have generated outstanding profits. However, following the strategy of investing in dividend cutters would have previously led investors to buy stock in the likes of Lehman Brothers (LEH), Eastman Kodak , Washington Mutual, Citigroup and Bank of America (BAC) after dividends were cut. This would have led to almost total wipe out of principal and the ability to generate dividend income from that portion of capital would have been substantially impaired.
The third reason why investors never succeed is because sitting on a stock that is working well, and doing absolutely nothing is very difficult. Few investors are psychologically ready to buy a stock, and see the company truly succeed over the next 10-20-30 years. If they sat on gains of several hundred percent, or even a thousand percent, they would ring the cash register. They could rationalize it by sayings such as “you never go broke taking a profit”. This is nonsense. An individual investor will have about 20 truly exceptional investment ideas over their lifetimes.
This could be from the anywhere between 50 to 100+ investments they would make over their lifetimes. The remaining 30 to 80 investment would be flat, lose money or make a small amount of money. Chances are that some of these would go to zero as well. Consistently cutting the successful investments short could be the deciding factor that could make an otherwise well picked portfolio of stocks lose money over time.