Wednesday, July 27, 2016

Implementing my DGI Strategy

It’s always good to have a strategy for investing. This article gives a brief summary of how I had implemented the necessary checklists and tools to make my job of investing DGI stocks easier.


First, a bit of history...


I’ve been a passive investor for a long time via my mutual funds in my tax-deferred 401k. This required not much work from my part. All I had to do was to choose my allocation and regularly invest using a portion of my paycheck. I reallocated once a while and that’s it. All good, right? No - the fees were high. At least for me.


Of course, if your 401k plan allows for a market wide fund with very low fees, then this may be an option especially if you don’t have the time. Essentially, I was paying for someone to actively invest companies in the index.


Around 2 years ago, I started dividend stock investing for my taxable account. I did a lot of reading and researching over the summer of 2014. For sure, it isn’t a strategy for everybody - but it made sense to me. The thing about a 2-4% dividend is that over time, the dividends will provide you a layer of protection against loss. Of course, it is not 100% protection, but it give you protection against 20-40% dips in the market. How? It’s simple, 3% over 10 years means a 30% buffer. It’s slightly more the dividends are reinvested and compounded, but I like simple math.


Plus, after retirement from work, the dividends can be used as income source without touching the principle.Hopefully, extra income can be reinvested to continue the compounding machine.


Regardless of dividend stocks and mutual funds, there are investing steps that I believe everyone should follow:


Understand the Level of Risk


Investing is individual stocks isn’t for everyone. If you cannot sleep because of a drop in a market, then you probably stick to safe investments such as money markets, CDs etc. When I started dividend stock investing, I ran a series of hypothetical experiments.


In my first experiment, http://div4son.blogspot.com/2015/03/patience-and-time.html, I realized that you need a lot of time and patience for dividend stock investing. There are some down years of 10-40%. This means I need to have the stomach to take huge dips in the market.


In my second experiment, http://div4son.blogspot.com/2015/04/experiments-with-dividend-reinvestment.html dividend reinvesments produced the best results. If your timespan is 20 years or more, the price movements are just noise in the grand scheme of things. Again, short-term losses can be huge, but time and patience are what you need. The only exception is when a company goes kaput - which is a possibility. Therefore, I needed protection for that.


In my third experiment,http://div4son.blogspot.com/2015/07/dividend-re-investment-experiments-part.html  I updated the spreadsheet for multiple companies, and checked the performances for both lump sum and regular investment intervals. I found that both lump sum and regular investments worked quite well. Again, all you need is time (and patience). Another important point is total value of the portfolio. Similar to experiments 1 & 2, there are years with huge losses. However, dividends Income grows year over year. Diversification over several companies can smooth out the randomness of gains and losses from individual companies. This is especially true if one of my companies go down the toilet.


The whole idea behind the experiments was to help me understand the risks, the timeframes involved.


I recently found the Risk Grade tool from Nasdaq. http://div4son.blogspot.com/2016/07/metric-risk.html After some reading, I figured out how to implement this tool using google sheets. http://div4son.blogspot.com/2016/07/risk-grade-tools-google-spreadsheets.html


After running risk grade charts for my portfolio, as well as the CCC list, I realized that not all companies have the risk characteristics. After plotting the histogram of the companies on the CCC list, it is clear to me that high relative risk grade > 2.0 can make gains difficult for your portfolio. High relative risk grades also correlated with companies with high yields.


Investment Timeframe


After running my experiments, it is clear that my investment timeframe is a very long time. This made me think. This isn’t about me any more. This is about my son. This is about his kids. This is about generational wealth.


Just last week, I was talking to a colleague at work about options investing. His timeframe is weekly to monthly. His buy and sell strategies are based on technicals. His fundamentals are based on earnings and revenues. I was actually happy that he has a method to his investment. I wasn’t shocked with his timeframe either. It is tailored to his investment style. His risk profile is very high - but again, that’s okay.


Investment Strategy


Investing can be very emotional. In order to take emotions out, I devised a strategy that I can follow. The strategy is tailored to my investment style, risk tolerance and the timeframe. It is obviously not suitable for everyone. But, this didn’t come overnight. At the beginning of 2014, I started researching books on Dividend stocks investing.


After several months,  I laid out my my investment strategy. You can read more about it here:


Of course having a strategy is one thing. Implementing it is another. In order to follow my guidelines, I had to implement several tools. I used a simple criteria checklist/table to compare my metrics.


Criteria Table Template




Ticker
Area
Criteria
CheckList
Quality Company
Dividend Growth
>5 years
Yes/No
ROE/Op Margin
Stable
Yes/No
Long term Avg Growth
Stable
Yes/No
FCF over Dividends
FCF>Dividend
Yes/No
M* Moat
Wide Moat
Yes/No
M* & S&P
Credit Rating
> BBB+
Yes/No
Cash to Debt & Interest Coverage, Debt to Equity
Cash Debt >1 or Interest Coverage > 5
Yes/No
M* & S&P Stars
> 3 Stars for both
Yes/No
Payout Ratio
<60%
Yes/No
Dividend Growth
& Yield
Dividend Yield
>3%
Yes/No
Dividend Growth
>5%
Yes/No
Chowder
>12%
Yes/No
Valuation
Yield/Avg Yield
>1.1
Yes/No
Dividend Yield Theory Mid Point
Below Mid Point
Yes/No
P/E
Below Mid Point
Yes/No
DRRM
~10%
Yes/No
M* Estimate
<M* est
Yes/No
S&P Estimate
< S&P cap IQ est
Yes/No


I’ve implemented my own version of the checklist which pulls the information from the internet. Of course, I also double check this with the company’s investor relation homepage. I also use the 10 years trends data to confirm my analysis.


I’ve also built an example template in case you want to build your own criteria table.


My strategy is to buy at fair value and below. I don’t want to buy a company when it is very expensive. This made sense to me. I don’t go to the grocery store and buy the most expensive items. There is no difference with stocks.


But what is a fair valuation? This was one of the things that kept me thinking a lot. After reading a lot, I ended using the following methods:
If you follow me, you know that I like to share my methods openly. You can get all three tools on google spreadsheets. https://div4son.blogspot.com/2016/01/d4s-valuation-tool.html


I also built a screen. Unfortunately, this spreadsheet is not prime time, so I cannot share it with you :(. The screen helps me scan the CCC list for criteria such as:
  • Payout Ratio < 0.75
  • P/E < 19
  • P/S < 1.5
  • P/B < 3.0
  • ROE > 15
  • M* Credit Rating > BBB
  • Mr. Chowder Rule > 10
  • Yield/Avg Yield > 1.10
  • PE/Avg PE < 1.0
  • M* Moat = Wide
  • Etc, etc
I also read my fellow bloggers for investment ideas.


In August, it will be my 2 years anniversary of DGI investing. I’ve think I did a fair job of implementing my strategy. Of course, with the market at its all time high, everyone is a genius. Knowing the risks, I know the market will go down again. Or, it can go further up. In any case, I will continue my regular investing.

Thanks for reading!

D4s

6 comments:

  1. Div4Son,

    Exactly. You can't predict where the market is going, but you know what you can do? Run your investment strategy on companies that you like and if they fit your criteria and you have the capital - then buy haha. That's what's great about dividend investing and the screeners/strategy tools we use - if it shows up within those criteria - you have a company worth investing into. Stay consistent and Hungry D4S!

    -Lanny

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    1. Lanny, thanks for your comments! I am vert hungry now especially when the market is not giving much :) D4s

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  2. Hey D4S,

    Really enjoyed reading through the evolution of your investing style and now you've found your perfect formula. And it's a rock solid formula, that's for sure. The market will definitely go down again, very hard at some point. When everyone is selling, that will be the perfect time to pounce :)

    Tristan

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    1. Yes - waiting for that time to pounce. In the mean time, just nibbling here and there. Thanks for visiting!
      D4s

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  3. Hi D4S,

    It's great that you've developed a comprehensive system that will allow you to make impartial investing decisions - congrats! :) I think that's really important to take some of the emotion / questioning out of stock purchases.

    I found your comment about dividends protecting against loss because of the dividend payment interesting. I used to think that too but I've been persuaded otherwise lately, since dividends aren't 'free'. That's not an argument against DGI however.

    Thanks for summarizing your strategy so well - it's always interesting to see other people's screens and criteria!

    Best wishes,
    -DL

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    Replies
    1. Thinking more about your comment, I agree that there's no protection is a company goes belly up. We need to focus on earnings and revenues regardless of DGI or not.
      D4s

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