In my previous post, I reflected upon my mixed experiences with mutual fund investing. This post will talk about my transition to buying individual stocks and my progression from being a client at a full-service brokerage firm to becoming a fully do-it-yourself (DIY) investor. I conclude with four more lessons learned on my journey to becoming a Stodgy Investor.
My Transition to Investing in Individual Stocks
As the value of my investment portfolio increased, the MER fees charged by my mutual funds were starting to add up and knowing that I was paying these fees was especially painful when the stock market had a bad year. After my mixed experiences with mutual fund investing, my stock broker and I began to transition the equity portion of my portfolio to individual stocks in the early 2000’s.
Some of the stocks I acquired were Pfizer, Power Financial (subsequently merged into Power Corp.), Husky Energy (subsequently taken over by Cenovus Energy), TransAlta and Sun Life Financial. All of these stocks paid relatively hefty dividends. Pfizer has been a reliable dividend grower since I purchased it. Power Corp. and Sun Life Financial have provided respectable (but below market) returns due to their insurance operations facing the headwind of decreasing interest rates for much longer than we (or anyone) anticipated. I have benefitted from the power of dividend growth through owning Pfizer, Power Corp. and Sun Life Financial shares for many years, as well as from reinvesting the dividends to buy shares of other high-quality companies.
The two remaining stocks, Husky Energy and TransAlta, turned out to be “value traps” that eventually cut their dividends. A “value trap” is a stock that initially appears to offer value because it trades at a significant price discount to its peers, but subsequently never seems to get its act together. Some of the signs of a potential “value trap” are stagnant revenues and earnings, an unusually high dividend yield, very slow or no dividend growth and a growing debt load. These companies are often the first ones to cut their dividend when the next recession hits, which typically causes the stock price to tumble dramatically.
It is sometimes challenging for investors to discern the difference between a company dealing with short term operational issues, sometimes referred to as a turnaround situation, and a real “value trap.” In turnarounds, management makes the required changes to get the company back on a growth trajectory. “Value traps,” in contrast, are often businesses that have not responded appropriately to changing business conditions or offer goods or services that are gradually becoming obsolete.
Pfizer’s recent merging of their legacy Upjohn business with Mylan to form Viatris in November 2020 is an example of a successful corporate action, at least from the perspective of Pfizer shareholders. Pfizer is now a more growth-oriented company with significantly less debt on its balance sheet. (For the record, I kept and have slowly added to my Viatris shares that were spun-off from Pfizer.) Successful company turnarounds usually provide investors with excellent investment returns as the company begins to grow again.
DIY Investing with a Discount Broker
Discount brokers did not really become popular in Canada until the 1990’s as households began to connect to the internet in significant numbers. In the late 1990’s, I opened my first self-directed brokerage account, but maintained ties with my full-service brokerage firm. As I started to direct a portion of my savings into my self-directed brokerage account, I immediately recognized the need to upgrade my investing knowledge.
Investment Newsletters
My first DIY investment was a paid subscription to The Investment Reporter, published by MPL Communications. The publication was founded by George Armstrong way back in 1941. It is an excellent resource for novice investors to become more proficient in stock portfolio construction. One of my first takeaways from reading this newsletter was the importance of diversification into the major industry sectors. They also promoted using your U.S. stock picks to diversify into economic sectors that are not well represented in Canada. This always seemed like an imminently sensible approach. For those of you who are interested, The Investment Reporter is available at several Ottawa Public Library branches and may be available at other Canadian libraries.
I later subscribed to The Successful Investor newsletter, published by TSI Wealth Network. Patrick McKeough, the newsletter editor, keeps readers informed about the companies in his aggressive growth, conservative growth and income portfolios. The two newsletters promote a fairly similar investing style, which is not entirely surprising given that Patrick was editor of The Investment Reporter from 1974-1994. Both newsletters divide the stocks they cover into 5 industry sectors, namely financial, utility, consumer, industrial (or manufacturing) and resource. They recommend that investors construct a diversified portfolio by selecting stocks from all five industry sectors. Telecommunication stocks can be placed into either the consumer or utilities sector depending on your preference. Likewise, pipeline stocks can be considered as utility or energy stocks.
Personally, I add a technology sector and separate the resource stocks into energy/materials and precious metals in my tracking tool. The exact placement of companies is not critical as long as your industry sector target allocations are consistent with how you choose to group stocks.
The most important decision is to set allocations for each of your industry sectors based on your risk tolerance. If you have a long investment horizon of 30 years or more, then you probably want higher allocations to growth areas such as technology, financials and consumer discretionary stocks. On the other hand, retirees generally want more stability and often have significant weightings to utility and consumer staple stocks.
BNN Market Call
I became a big fan of BNN’s Market Call with Jim O’Connell in the late 1990’s. The show, which still broadcasts to this day, provides viewers with the opportunity to call-in (or email now) questions to a guest fund manager or market analyst. Jim was a truly wonderful host of the show and I was truly saddened when he passed away in 2007. Some of my favorite guests on the show include Ross Healy, Ron Meisels, David Driscoll (who coincidently was editor of The Investment Reporter from 1994-1997), David Baskin and Benj Gallander. Although each of these investors has their own individual investing style and method for analyzing stocks, they all offer common sense approaches to investing.
As I became more knowledgeable, I started to filter out guests that followed completely different investing strategies. This seems like a self-limiting thing to do, but I found that the comments provided by some analysts made me doubt my stock selections and, in fact, contributed to me selling some high-quality stocks based on what I would now call market noise. Eventually, I began to see many analyst best picks to be short term momentum plays that were not in the best interest of an investor who planned to buy and hold their investments forever.
Many financial analysts and advisors push investors to tilt their portfolios heavily to the hottest sectors and stocks. The problem with this approach is that market leadership changes over time and this leads to relatively large portfolio turnover. Of course, this approach serves the financial services industry quite well as it leads to higher commission fees. It also leads to paying more capital gains taxes, which reduces the capital you have invested in the stock market.
Buy and Hold Forever Approach
The buy and hold forever approach minimizes commission fees and capital gains taxes can be deferred for long periods of time, which is much better for the investor and the economy. One of the benefits of a buy and hold stock strategy is that you get to understand how the companies you own operate and how their stocks trade in the market. This enables the investor to become progressively more aware when opportune times present themselves to add to a particular stock holding.
My TD bank (TD-T) holding demonstrates this concept. I made my initial purchase of TD Bank in January 2015 at a purchase price of $50.82. This seemed like a reasonable decision at the time as it offered a 3.7% dividend, which was about the stock’s average for the past 10 years. The stock price remained in the $48 to $55 range for a year before moving up to $80 by mid-2018. Then, the stock dropped like a stone to $50 in March 2020. Even though the market was chaotic at the time, I did not hesitate to pick up additional shares of TD Bank at $50.25 with the stock now offering a 6.3% yield. I did not worry for a second that the share price had not gone up in over 5 years. The purchase proved to be wise as the stock price has since rebounded to the $80 range.
Investors know that most stocks were on sale in mid-March 2020. This is fairly obvious in hindsight. What is really important is that investors have the courage of their convictions to confidently buy when there is rampant pessimism in the market. I was able to do that with TD Bank and a few other companies in March 2020 because I had good knowledge about the value offered by the companies I was buying.
I kept my RRSP account with a full-service brokerage company for 20 years after I started my journey towards DIY investing. I only severed ties with the full-service brokerage firm when I felt competent and confident enough to manage my entire investment portfolio. I still maintain a paid subscription with Dividend Stocks Rock to provide a second set of eyes on my companies, as well as to identify companies I may want to own.
In closing, I would be remiss if I didn’t say that investors embracing a buy and hold forever mentality still have to carefully monitor their stock holdings. The best way to do this is to read the quarterly reports issued by each company. High-quality companies do lose their way on occasion and need to be replaced in your stock portfolio with a better company. I will talk more about this in a future post.
Valuable Lessons 5-8
The fifth lesson I learned on my journey to becoming a Stodgy Investor is that compounding is the secret to investment success. Buy dividend growth stocks and hold them for a long period of time. This will allow your income to grow exponentially through a combination of higher dividend payments per share and an increase in the number of shares you own through reinvesting your dividends. Most importantly, dividend growth investing shifts the focus from stock prices and portfolio value to growing your dividend income stream. When your cash flow matches your annual expenses, you become financially independent. This important shift in thinking allows you to no longer fear stock market declines. Instead, they become opportunities to increase your cash flow at a very reasonable cost.
The sixth lesson is that the core of a buy and hold portfolio should be high-quality companies that provide essential goods and services. Look for companies that have an enduring competitive advantage (called an economic moat), or that operate as an oligopoly. In Canada, companies that fit this criteria include our major banks, insurance companies, grocers, telecommunications companies, railways, electric utilities and pipelines. Use the U.S. market to diversify into consumer packaged goods (CPG) companies, pharmaceuticals, big box retailers and large technology companies.
The seventh lesson is that it is generally wise to pay up for higher-quality companies that demonstrate a reasonable growth profile over buying lower-quality companies trading at a discount Price/Earnings multiple. The bargain stocks often prove to be “value traps” in the long run. Focus on companies that have a consistent dividend growth profile over companies that may pay a higher dividend, but have a spotty track record of dividend growth. The current dividend yield and the long-term dividend growth rate are two important metrics for investors that are focused on building a portfolio that delivers a reliable and growing cash flow over time. Avoid companies that have a history of cutting their dividend.
The eighth and final lesson is that valuation definitely matters when you are a value investor. You will improve your investment performance by taking the time to understand how the market values the stocks you hold and those you wish to buy. This will enable you to add to your stock positions with conviction when they are on sale.
In summary, this post has provided some historical context to how I became a Stodgy Investor. It has revealed eight valuable lessons that I have learned on my investing journey. I plan to reveal more details about my investing process in subsequent posts. My investing approach works for me and is suitable for patient investors who are more conservative by nature. It may also work for investors who have not been successful with other approaches. Investors who buy high-quality companies and hold them for a long period of time have a high probability of becoming financially independent and subsequently preserving their wealth.
Four Questions to Consider
- How do you identify core stocks to buy and hold in your portfolio?
- Do your have a balanced portfolio with stocks from a number of industry sectors?
- Do you hold any potential “value traps” in your portfolio? What is your criteria for reviewing your holdings?
- Do you add to your existing stock positions when they go on sale?
I look forward to hearing your thoughts on any of these questions in the comments section.