Dividend Investing Vs. Value Investing

There is no topic that seems to draw as many internal contradictions as the discussion of money. This is true if you have a biblical worldview—you have to reconcile assertions that money is the root of evil with an imperative to leave an inheritance for your grandchildren’s grandchildren. You have Jesus Christ Himself telling you that it is easier for a camel to get through the eye of a needle than for a rich man to get in heaven, and then telling you the Parable of the Talents that rewards productivity and virtue over short-term thinking.

This is also true if you have a more secular worldview—how many parents have you heard say “money doesn’t matter—I only want my kids to be happy” –yet if they got to choose the person their sons and daughters married, which suitor do you think they would prefer between company vice president or aspiring beatnik poet? Why do you think that is?

And to narrow the conversation down even further to the terms that we usually discuss on this website, think about all of the conflicting advice we get from Benjamin Graham and his star apostle, Warren Buffett. In Graham’s vocabulary, it would be nuts to buy and hold for decades and decades. You buy something cheap, wait for it to be priced at what it is worth, and then you sell it. Wash. Rinse. And repeat.

And yet, Warren Buffett is sitting on those same shares of Coca-Cola that he bought in the late 1980s and early 1990s, turning a $1.3 billion investment into something worth $15 billion today—and that does not even factor in the two decades worth of dividends that Coca-Cola has deployed to Omaha headquarters, giving Warren Buffett a relentless infusion of cash profits to make brand new investments that can, you guessed it, make cash profits.

When your mind starts thinking about this stuff, it’s natural to wonder—do I buy something and watch it grow until I die, or do I buy something with the predetermined intention to sell at a particular point?

Here’s how I break down the classifications.

I put every company I categorize into two categories:

(1)    Companies that are highly likely to be profitable 25, 30, 35 years from now. For me, that means companies like Coca-Cola, Disney, Kraft, Hershey, PepsiCo, Johnson & Johnson, Procter & Gamble, and some others.

(2)    Companies that are profitable now, but I have no ability to make predictions about their profits 20+ years from now. I own IBM, but I have no idea what it will look like in 2035. I’ll probably own Wal-Mart and Walgreen at some point, but I wouldn’t delude myself into thinking that I could hold those companies for decades without thinking much about them, because that is not the nature of retail investing.

Once you properly categorize the companies that you are considering purchasing, it is a lot easier to develop a sensible sale strategy.

For companies in the first category, the time to sell is “never” or “nearly never” to allow for wild things like Coca-Cola selling at 50x earnings or something crazy like that, in which case, the opportunity cost of not selling becomes so high that you would be wise to unload your shares. If someone wants to give me $230 for Johnson & Johnson stock, fine—take it. The hassle of finding something new is worth selling because the price would be exorbitantly higher than true value.

However, once you enter the category of those second-tier companies, it can make a lot of sense to sell at signs of fair value or slight overvaluation. If I owned Walgreens and it went up to $75 next week, and I held the shares within a tax-protected account, I would not hesitate to sell the stock because it lacks the high likelihood that it will be more profitable 25+ years from now, so I would be more agreeable to selling the company in response to mild overvaluation.

The logic is that when you invest money, you need to have a purpose for that money.

When I buy Johnson & Johnson or Procter & Gamble, the general point is to be receiving somewhere around $3.00 in immediate income on every $100 that I invest, and I want those $3.00 cash deposits to grow by 7-10% every year thereafter (this is easily doable if you can reinvest along the way). It’s hard to find assets that will give you more and more money until you die, but those kinds of companies are probably some of the best places where you can start.

Other investments do not share the same purpose of constant dividend growth, but are sought after because they are cheap. That’s my personal story with Bank of America. If I wanted to hold something for thirty years, I’d be looking to US Bancorp, Wells Fargo, or JP Morgan. But Bank of America was cheap at $7-$8, so I bought it. If I went up to $25 per share by the end of the year, I’d have no problem selling it because the purpose was more in line with medium term wealth-building (rather than being like Phil Fisher’s Motorola investment that got bought in the 1950s and held until death).

There is no right or wrong answer per se; you may think that Wal-Mart is a stock you can hold until 2040, I might think it’s something that requires regular monitoring. Not a big deal. But the key is to think terms of the companies you own whose purpose is primary to give you bigger and bigger cash deposits each year that act as wealth anchors, and to differentiate them from  companies that you buy simply because they are solid and selling for less than the price you think its worth. Know what kind of investments you prefer, and then tie the purpose of your general investing strategy into your thought process at the time you buy a stock. If you buy without an end game to sell, the answer is clear—you only get rid of the stock if the company’s profit engine is falling apart or if it is selling for something absurd like 50x earnings. If you don’t want to attach such permanence to an investment, then you wash your hands of the stock once the stock price surpasses what you think it is worth.


Originally posted 2013-12-02 08:12:44.

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