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3 Ideas That Can Jeopardize Your Dividend Investing Success

Ratios and 'perma-bears'

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I have been writing about dividend investing on my website since 2008. This was a very tumultuous period for investors, which included sharp drops in prices through 2009, followed by a relentless recovery in stock prices ever since. As someone who gets a lot of interaction with regular investors through my website, I get to develop an understanding of popular investor sentiment almost at all times.

As a long term investor, I find overall investor sentiment to be counterproductive for me, because it removes my focus on what really matters for my investing strategy. In my strategy, I try to acquire tiny pieces of ownership at attractive valuations, in large established dividend growing companies . These companies usually have a product or service that is unique and which customers purchase repeatedly. Many of these products are essentials that people use on an everyday basis, and are therefore relatively immune to recessions.

The goal is also to purchase businesses that I can understand, and that would still be there in 20 years, while maintaining a strong competitive position. I also try to determine whether there are any catalysts that would bring more earnings per share and hopefully more dividends in 10 – 20 years. I

expect to hold on to these companies for decades, or until something material changes that would make me want to sell. As such, I do not try forecast the direction of the stock market. In order to make my living. I simply have to find enough quality businesses selling at fair prices, and put my capital there.

My success as an investor will depend on the overall level of success of the collection of businesses I partially own in my portfolio. For example, if Colgate Palmolive (CL) manages to sell more toothpaste in 20 – 30 years, it would likely earn more and pay higher dividends to me.

In addition, if the rising number of babies in the US and China translates into the need for more diapers every year, Procter & Gamble (PG) would be able to sell more to new mothers. This is the type of things you should focus on as a long-term investor. In contrast, a lot of investors try to forecast interest rates, economic growth, quarterly earnings and so forth. This might be helpful for anyone who actively trades the markets, but is pretty useless for me as an investor in businesses.

Ever since the end of 2009, the common sentiment I have heard from investors is that stocks are too high. I have been hearing that at least several times per year since then. There is always “a reason” why stocks as a whole should not go up. So far in 2013, I have been hearing that non-stop. Two indicators that many investors seems to be using as a reason to avoid stocks these days are the market capitalization to GDP ratio, and the Schiller CAPE Ratio. The last item I will discuss are perma-bears, and the dangers they pose for long-term investors.

The market capitalization to GDP indicator is calculated by dividing the total US market capitalization to the level of GDP. Extremely high levels are supposed to have predicted the 1929 stock market collapse.

However, I do not subscribe to this black magic for a few reasons. The first is that the increase in this ratio might not mean anything, especially as we have an increased financialization of assets. Estimated wealth in the US is approximately 3- 4 times the level of GDP or market capitalization. If all the office buildings or rental units are no longer owned by private landlords, but are owned by publicly traded companies listed on NYSE, this would increase the Market Cap to GDP ratio.

Therefore, all the increase in Market Cap to GDP ratio would show is that most of the wealth is now listed on a stock exchange. The second reason I believe that the Market cap to GDP is not useful these days, is because a large portion of US company profits are generated outside the US.

For example, the ten largest components of S&P 500 derive almost half of sales from outside the US. In reality, I am not sure why any change in the market capitalization to GDP would mean anything of value to the dividend investor. A dividend investor should look at individual companies, and how their business is doing, and not make a macro bet on things.


I also don’t follow Shillers Cyclically Adjusted P/E Ratio (CAPE), because it gives value to earnings which happened 10years ago. For example, if a stock earned $50 per share starting in 2004 for 5 years, but for past 5 years earns $100 per share and EPS is relatively sustainable, should the stock be valued at 15 times times $75 (average of EPS over the past decade) or 15 times $100? This indicator has had stocks overvalued for several years since 2009, and currently is close to 25. In reality, S&P 500 has a P/E ratio of 18 or 19 times earnings, which got a little overstretched in 2013. Based on forward estimate however, the P/E ratio on stocks in general looks fair. However, as an individual investor, my goal is to pick individual stocks, not have opinions on everything that is publicly traded on a stock exchange.


Source: Multipl

To put it in layman terms, in my previous job, new hires started at $48,000/year. Approximately 10 years before, the starting salary was $36,000/year. During recruiting, the potential new hires never asked the recruiter what the salary was five or ten years ago. All they cared about is the income they will make this year.

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