My Warning: this article will not be easy to read for most of you. I’m not reciting classic investing mistakes with some generic solutions. I’m attacking the top investing mistakes I’ve seen across the DSR community over the past 8 years. This article covers two of them.
In the following pages, I will not only identify what most investors do wrong, but why they do it and how it hurts their retirement plan. The worst mistakes are often the ones we don’t see. You don’t even realize it’s a mistake since it’s not making you lose money right away. The impact is only visible over a long period of time. It’s like my eternal battle with weight loss.
I’ve been trying to lose weight for several years. It’s a classic resolution most of us make and then forget along the way. The thing is that I don’t forget about it. I even have a plan to make sure I achieve my goal! Over the past 10 years, I’ve made sure to “stay in shape” as I was going through my 30’s. I had been going to the gym regularly until I eventually built one in my basement. I’ve been running 3-4 times a week and even completed a half-marathon. Last year, I ran a total of 836.8km. This year, I’m on target to go above 1,000km! Not bad for a guy who lives in a country where winter lasts 4 months a year!
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Do you know how many pounds I lost? None. For all those years, all I have been able to do is to maintain the same weight. I always had a solid training plan and followed it. Nevertheless, my story is like Groundhog Day. Do you know why?
I make the same “invisible mistake” each year.
Sometimes it is called “the weekend”, and sometimes it is “a good glass of wine by the terrace”. But each year, the mistake I make is not about training intensity, the quality of my plan or my diligence. The mistake I make is about eating too much.
You may feel your portfolio is in good shape. In fact, if it is not, it would be quite surprising considering how great the stock market has been to all investors over the past decade. This is the market covering up for your mistakes. Lucky for you, there is still time to solve these issues and get your portfolio on the right track.
I know very well the following investing missteps as I’ve experienced most of them during my investing journey. We usually say that the ultimate result of a mistake is to allow us to learn something. Let’s explore together those errors and learn how you can fix your portfolio using DSR tools.
#1 - WAITING FOR A PULLBACK
“Buy low, sell high”. That is the most basic and sound investing advice we can give to anybody starting their investing journey. Now, what do you do when the stock market keeps going higher and higher? You are not going to buy high (and sell low), are you? This is how you end-up waiting for a pullback. Now that we are currently trading close to an all-time high, it’s even more tempting to wait for the next crash.
Why are you doing this?
History is filled with investing horror stories. During the past 20 years alone, we had the “chance” of running into the tech bubble, the Twin Tower terrorist attack, the 2008 financial crisis, the oil bust in 2015, the 2018 quick bear market, the 2020 pandemic crash and we are about to see how fast this aging bull market might crash. Keeping cash aside for the next crash tells a seducing story: you will buy shares at an incredibly low price, and they will eventually go back up and generate strong returns. After all, why would you buy now, if you can buy later at a cheaper price? Plus, keeping 30% of your money in cash doesn’t make you lose money. It looks like a win-win situation as you get paid (e.g., mediocre interest rate) on your cash and you will eventually get bargains in the stock market.
For an inexplicable reason, most investors keep referring to what happened in 2008-2009 as the norm for a market crash. They expect the next bear market to be fast and furious (pun intended). Therefore, all you need to do is to wait for a few months until the bleeding stops. Then, you put all your money in, and you feel like a king.
The Canadian market almost tripled in value while the U.S. market soared by more than 700%! This is enough for any investor to be “set for life” if they played their cards correctly back in 2009. When you look at this graph, waiting for a pullback makes total sense. Unfortunately, you are wrong.
How it hurts your portfolio
If a year like 2009 happened every 5 or even every 10 years, waiting for a major pullback would be a defendable strategy. After all, any investor who put his money to work in 2009 shows impressive results today. I remember that the famous Canadian Banks were offering yields of between 7% and 9% at their bottom. Just the thought of buying Royal Bank (RY.TO) with a 7+% yield makes me smile… but it is unlikely to happen. In fact, this happened only once in the past 25 years (with a special mention to 2020 where you could have caught RY with a 5% yield). Waiting for such a pullback to get “market deals” is more like waiting to see the Habs win the Stanley Cup (this also happened once in the past 25 years). The problem is that we rarely have the chance to invest after a major stock market correction.
Since 1970, there have only been 3 interesting pullbacks that would have been worth the wait (1973-74, 2000-01-02 and 2008-09). Imagine if the market correction of 2018 happened similarly to the one in 1990. This would mean that you would be waiting another 9 years before a market crash. Can you afford waiting another decade before investing? Do you think the next market crash will bring prices back to the 90’s? Here’s my blunt answer; it won’t.
But waiting has a more important impact on your portfolio: it inserts doubt into your investing plan. You want an example? How many of you (or your friends) invested all their available money on December 26th, 2018? After both markets showed a strong double-digit decrease from their peak levels. Wasn’t that the pullback you were waiting for? Like most of us, you didn’t know that the end of 2018 would mark the start of another bullish segment. You probably didn’t invest more money in December 2018 because you started thinking about the possibility of another 2008. Even worse, what if the market moved into another bear segment like the one in 2000-2002? The same question could easily apply to the crazy year of 2020. If you tell me that you are waiting for a pull-back now, where were you in March of 2020? As mentioned in our investment bias newsletter, it’s very easy to play Monday morning quarterback as hindsight is truly 20-20!) (quote from Goldman Sachs)
“At ValuEngine.com we show that 77.8% of all stocks are overvalued, 45.2% by 20% or more. All 16 sectors are overvalued; consumer staples by 17.6%, retail-wholesale by 26.4% and utilities by 9.8%.”
“The market has jumped nearly 30%. This means the stock market’s rally has been based solely on people paying more money for the same amount of earnings — this is known as “P/E multiple expansion.”
In 2017, I officially quit my job as a private banker and invested 100% of the commuted value of my pension plan in dividend growth stocks. Then again, everybody agreed the market was way overvalued back then. In other words, most investors agreed the market was overvalued for 4 consecutive years. What do those people say today?... you know that already.. You will see that even during the market correction of 2018, our portfolio minimized its losses by focusing on dividend growing stocks.
The best protection there is against a market crash is a solid portfolio. One way to build such a portfolio is to select companies with robust dividend growth. A quick search across our stock screener will help you identify those hidden gems.
In a few simple clicks, you can set the filters and begin hunting for the best stocks:
- Minimum Pro Rating 3
- Minimum Dividend Safety Score 3
- Minimum 5yr EPS growth of 1%
- Minimum 5yr revenue growth of growth of 1%
- Minimum 5yr dividend 1%
By selecting only companies showing positive numbers in the 5yr Rev growth, 5yr EPS growth and 5yr Div. growth columns, you will find companies with a positive dividend triangle.
This methodology covers all “regular companies”, but not REITs and other businesses that use non-conventional metrics instead of EPS. We will address those types of companies later in this letter.
As of July 2021, these simple filters would bring down the dividend universe to 228 candidates for your portfolio. You can slash this list by 64% by selecting only companies with a Pro rating of 4. Even better, you can try different combinations and save your views (e.g. save your favorite filters) if you are a DSR PRO member.
You can then, select the “columns” button and add as many financial metrics as you want. While the stock screener is limited on the number of metrics it can show on your screen, you can export the file as a “csv”, which is an excel spreadsheet.
You will be able to search through several metrics and identify the cream of the crop for each sector and each market. Going through this list by selecting only the strongest dividend growers will increase your protection against any future market crash. Plus, cross-checking our ratings with your portfolio will highlight your holdings that are most susceptible to cutting their dividend in the event of a recession.
Your quarterly DSR PRO report highlights your weakest stocks (DSR PRO or dividend safety score under 3). Then, the Potential Replacements list will identify all the stocks in the same sector with stronger ratings. For example, imagine you have Wells Fargo (WFC) in your portfolio. At DSR, it has a DSR PRO rating of 2 and a dividend safety score of 2. In your PRO report, the replacement list would show stocks like JP Morgan (PRO rating of 4 and dividend safety score of 3) or BlackRock (BLK (Pro rating of 4 and dividend safety score of 4).
Selling your weakest holdings during a bull market is a good way to “buy low and sell high” while improving your overall portfolio for the years to come.
Finally, while the market isn’t going down right now, this doesn’t mean you won’t find companies getting hurt temporarily. The goal of the Mike’s Buy list (updated monthly) is to capture those temporary drops and determine if they are justified or not. You can then invest in momentary pullbacks for specific companies or industries and finally put your money to work for you.
The Mike’s buy list discusses stocks we like but were hurt by the market for one reason or another. This is a good place to find the few “undervalued” stocks of the moment.
#2 - THINKING IT WILL BOUNCE BACK
While some investors wait desperately for a market pullback to invest, some others are fully invested in the wrong companies. Making poor investment decisions happens to all investors from time to time. When you look at my current pension portfolio, you will notice that not all my holdings are showing positive returns. My positions in Lassonde (LAS.A.TO), Magna International (MG.TO) and Andrew Peller (ADW.A.TO) were in the red, about 30 months after I bought those securities. For a while, I’ve patiently waited, but I sold my shares of Lassonde as the company never met my investment thesis. Magna International eventually bounced back and soared while Andrew Peller is still going sideways.
Why are you doing this?
The rationale used here is like the wait for a pullback: you don’t want to buy high and sell low. The first 10-20% loss can be justified by a temporary setback. “The market doesn’t get it”, or “investors will realize this is a good company” are often the rationales employed. You may also try to justify your purchase by any means. It is hard for anybody to admit their mistakes. I can tell you I wasn’t happy to be wrong about FedEx (FDX) in my February Mike’s Buy List, and I had to eventually admit that I picked the wrong company. This hurts our ego, and our brain seems to do everything in its power to protect that ego. For that reason, we often patiently wait for our losers to come back on track and prove us right.
We also comfort ourselves by telling ourselves that selling at a bad time is acting on fear. We don’t want to let our emotions take the wheel and drive our portfolio transactions. While this is a good reflex to have, further analysis must be done before making the final decision on whether to keep a given stock in our portfolio.
How it hurts your portfolio
Many investors will tend to let their losers run as they will consider the money lost. Once you have made a bad investment and you are losing 40% of your capital, what could go wrong from there? How could you possibly lose more money than what you already lost? If that is the case, you are likely to keep your shares and think that one day it will bounce back, and you could recover your money.
In this case, what you are leaving on the table is the opportunity cost of keeping your money invested in a bad place. What if you cut your losses and bought shares of a strong dividend grower instead? There is obviously the possibility of making another mistake, but since you already made one, you should learn from it. For example, look at the graph of some famous companies who cut their dividend not too long ago. Do you really think you will do worse if you sell your loser(s) now and buy something else with better prospects?
Once again, allow me to share a personal story. A few years ago, I held shares of a company who failed me: Black Diamond Group (BDI.TO). The company saw challenging times coming after the oil bust of 2014-2016 and management decided to cut their dividend. Following my investing principles, I took my loss and sold all my shares right away. I wasn’t happy to lose money and I felt a bit dumb for having Black Diamond in my portfolio in the first place. After all, I was wrong with my investment thesis, and I wasn’t fast enough to see the dividend cut coming.
Instead of whining about my bad investment, I sold my shares and moved on. With the proceeds of my transaction, I bought shares of Canadian National Railway (CNR.TO / CNI). The rest is history:
If I had waited for better days with Black Diamond, I would have suffered a second dividend cut and lost even more money. At the same time, my new shares of CNR kept increasing the dividend and my shares have appreciated in value substantially.
How can you fix it?
At DSR, we review about 1,000 companies through our DSR PRO service. Each quarter, we review each earnings report, and we rate those companies for our DSR PRO members. Most companies we rate as “sell” usually end-up lagging the market. Most companies we rate as “buy” usually perform well. By cross-referencing our ratings with your portfolio (using the stock card page or excel file download), you can easily identify which stocks you should evaluate further for future investment. Then, you can look at each company’s individual stock card and read the investment thesis and potential downsides to assess the company’s risk for a new investment.
Let’s take Altria (MO) for example. The stock hasn’t generated much in the past 5 years and offers a yield above 7%. You may wonder if you should keep this stock or not. You look “MO” up in the stock screener and find out that it has a PRO rating of “2” and a dividend safety score of “3”. You can go read the stock card and consider other metrics published on that page (data updated weekly).
You can readily see we are not a fan of MO. But that is our investment thesis. This is our reason why we decided not to invest in this security. This does not mean we are correct and you should sell immediately. However, this is a very good start for you to think about the other side of the coin. By confronting your investment thesis with ours, you will be in a better place to determine whether you should keep your shares. This is how you will gain confidence about the next move to make. Again, consistent use of our DSR tools will allow you to be a better investor.
If you are looking for more incentive to act on this security, I would suggest you keep reading the stock card by analyzing the dividend triangle and read Altria’s potential risk section.
In this case, I think you must cut your losses and find a better performing company.
If you are holding a few companies that you are unsure about and you see they show a “sell rating” on top of a poor dividend safety score, maybe you should listen to your doubts and get rid of them. Each stock card will show you the dividend triangle (revenue, earnings, and dividend growth). A weak dividend triangle will usually lead to poor performance for that security on the markets going forward.
I like to make use of the hiking analogy to describe our investing journey. We know where we start, we know a great deal about the road ahead, and we are certainly aware of our destination. However, we must face various challenges throughout our journey. We sometimes make bad decisions, and we must learn from them. As your hiking buddy, I hope this newsletter found you well and helped you in the management of the potential pitfalls in your portfolio.
As the market continues to evolve with growth (i.e., breaking records pretty much each month!), you still have time to review your portfolio and make sure you are not making any of these invisible missteps. If you think of any other investing mistakes I should add in the future, let me know. As always, you are a great source of inspiration!
Mike Heroux, Passionate Investor & founder of Dividend Stocks Rock
P.S. Are you concerned by the current state of the market? I recently hosted a free webinar on What To Buy In This Overvalued Market? Know What to Buy, Know When to Sell.
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**Please do your own due-diligence before investing in any stocks we discuss in this article**
I may hold shares of companies discussed in this article.