A Dividend Investor’s Work Ethic

 “I took my job of self-education very seriously. I got myself a small looseleaf notebook, and on each page I wrote the salient data about a given bond issue in convenient form to be memorized. After all these years, I can still remember the appearance of that black notebook and some of the entries in it. The first was ‘Atchison, Topeka, & Santa Fe, General 4s, due 1995: 150 mil.’ There must have been a hundred different issues entered; I memorized their size, interest, maturity date, and order of lien. Why I wanted to memorize facts that could be readily obtained from manuals or my notebook I am at a loss to explain… I had become something of a walking Railroad Bond Manual.” –Benjamin Graham

In his 30s and 40s, Graham's dedication to investing and work ethic was unparalleled, perhaps only matched by his heir apparent.

From everything I’ve read, Graham’s dedication to investing during his 30s and 40s was about what you would expect from a man who wrote the treatise “The Intelligent Investor.”

It doesn’t get mentioned nearly enough, but investing is a cumulative process—while it’s not exactly analogous to the bike metaphor that once you learn how to ride a bike, you never you forget—it is close.

A lot of asset managers include the following question in their questionnaires or surveys when they seek new clients: “Have you beaten a benchmark such as the S&P 500 over the past three, five, ten years?” The answer to all three could be a resounding no, and that’s why you need someone’s help. Who knows, that kind of stuff varies person to person. But what is usually discounted is the possibility that you can improve as an investor over time.

In literature, we picture Warren Buffett, Donald Yacktman, Benjamin Graham, and so on, as these static creatures that have always had this omniscient well of knowledge about businesses. No—there was a time when Buffett didn’t know what a dividend was, Yacktman didn’t know what a stock split meant, and Graham didn’t know what a stock buyback could do. And even later on in their lives, they didn’t stop learning—I guarantee that if Graham started writing once the full force of his GEICO investment became clear, he would have been more like Charlie Munger and would have spoken in terms of “sit on your ass” investments with much more frequency than you could find in his writings.

Graham’s style of investing required a shrewd, insatiable work ethic because he was always buying and selling something. You can’t “chill” and go through life for five years while ignoring a particular security if you want to do things the Graham at the time he was running the Graham-Newman corporation. When NFL players hit the practice fields for two-a-days here pretty soon (if they haven’t started already), they will be doing the physical equivalent of what Graham was doing mentally during his heyday—investing with a ferocity and tenacity that it is the only thing on your mind for twelve, fourteen hours per day. In fact, that’s one of the perplexing things about Graham’s life—you can’t help but wonder how he was able to be such a womanizer and get around town so much given his extensive work ethic (in his later life, he did slow down and start taking lengthy vacations, but from what I can gather, he was a bulldozer in his 30s and 40s).

Personally, I think the art of investing can be boiled down quite simply if you can acquire knowledge of the following things:

1. Figure out how much stock the company is buying back (for instance, Exxon buys backs 3-6% of its stock per year going back three decades—this is something you should know about the investments you select).

2. Figure out how what percentage of profits go to the dividend, and what this payout ratio has been historically (as well as what the dividends have been historically).

3. Look at the product lines to figure out what percentage of profits come from each product (for instance, Apple is a phone company because half their profits are tied to the iPhone. If the iPhone falls, Apple’s valuation would fairly cut in half).

4. Get a handle on the company’s appropriate valuation in normal times (a good rule of thumb is this: look at the past decade, and manually remove the excessive P/E ratios, on both the high and low side. Take the remaining figure, and from there, determine whether the company’s future is brighter or duller than what it would have been in the past decade. If you anticipate faster growth, you should be willing to accept a lower earnings yield. If you anticipate lower growth, you could be walking into a trap by thinking you’re getting a fair deal, historically speaking).

5. Figure out which direction a company’s balance sheet is heading in. (is debt increasing? Decreasing? Because interest rates are so low right now, most S&P 500 companies are increasing the debt on their balance sheets to pay a growing dividend because profits are overseas and cannot be brought back without losing a third to taxes, or the company wants to take on debt to repurchase stock, refinance, or grow the business).

6. Tie your predictions to probabilities, which is usually judged in connection with the quality of the firm (it’s a lot easier predicting that Johnson & Johnson will grow by 8% or a bit more over the next 15 years than it is trying to figure out what Netflix will be doing).

7. Study for hidden risks (for instance, Dr. Pepper has concentrated bottling operations—if the New Madrid Fault were to do its thing again and wipe out St. Louis, then Dr. Pepper is going to get hit harder by that event that PepsiCo shareholders. Concentrated bets are not bad, but you should be aware of what they are, and make sure that the risk of harm is low before going forward to invest).

You can get a lot of lifetime mileage out of simply following those seven things. Someone who recognized that Colgate-Palmolive was a great company in 1977 and threw down $10,000 to benefit from that observation would be sitting on $1.3 million today. The millionaire was created by three things: observation of an excellent company + acquisition of an excellent company + the passage of time. The seven tools mentioned above are important in making sure you get the company, and when warranted, valuation right.