Charlie Munger: The Psychology of Human Misjudgement

I came across this video and really like to share this one with you. It looks great, enjoy watching this video. All credits go to Tiny, the maker of this clip.

 

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Stock Ideas for June 2018

We’re almost halfway 2018 and it looks like this year is going to be a solid year in terms of conscientiously investing my savings in dividend growth stocks. Throughout this year I’ve been able to buy stocks every month and in some cases I really locked in some nice yields. Wild swings in the stock market gave us the opportunity to buy terrific companies at low or reasonable valuations. The last twelve months I’ve put most of my monthly savings in REITs – KIM, O, OHI, SKT, VTR – and other companies like MO, PEP, T and XOM. These are all high-yielding stocks. I really like that idea. And yes, some have a low dividend growth rate. It’s true that the dividend growth rate matters in a big way for increasing our net worth. But when these stocks trade for such low valuations, I really think there’s no harm in investing your money in dividend growth stocks with a lower than average dividend growth rate for a while. Besides, I’m convinced that some names will show higher growth numbers in a year or two. Let’s get back to the subject, please…

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This Friday I will be able to invest a welcome amount of fresh capital of $1.000. The last couple of days I’ve been thinking about which stocks to buy. I really like that feeling of knowing these investments will get me a nice and growing income for the years ahead. The looming trade wars of the USA with China and the EU and the prospect of rising interest rates have resulted in some great businesses trading at low or reasonable valuations and high dividend yields.

I’d love to buy me a beaten down business in the consumer goods sector again. Last month I started a position in PEP. Man, was I excited about this buy! It’s really cool to see people standing in front of you at the grocery store, paying for drinks and snacks of the company you own. The stocks which are currently (still) on the buy list for many dividend growth investors lately are GIS, KHC, KMB, PEP and PG. My favorites are GIS and KMB. I don’t own stocks of these companies yet.

I’m not a big fan of KHC for example. I’d love to own a part of their flagship product Heinz. It’s an amazing product and it has been around for more than 150 years. My little daughters are already insisting on their dollop of ketchup at dinner. No matter what we eat ☺️. I think the Board will get the company on track with cost reductions and slimming down their product portfolio. Buffett is very positive about 3G Capital and their cost cutting strategy for KHC. That’s a real plus. But, I don’t feel quite comfortable about their pile of debt and dividend growth in the future. I don’t know, maybe I’m too pessimistic on this company.

Additions to existing positions like SKT and VTR is also an attractive possibility. Prices have gone up lately and I feel like the pessimism has shifted towards a more neutral stand by the market. I do think these stocks will remain volatile this year so there’s a big chance this opportunity will last for a while. But, who knows? Their dividends are safe and yield around 6.0% at the moment.

JNJ is also on my radar again. This is a true gem, as we all know. It’s a wonderful and a steadily growing business, yielding just shy of 3% these days. I’d love to add this quality name to my basket.

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*: Heinz had built up quite a track record regarding paying dividends and was a Dividend Aristocrat for more than a decade until it lowered its dividend back in 2003. Since 2004, Heinz has increased its dividend annually. Kraft was a spinoff from Mondelez International. As a standalone company Mondelez put together a respectable track record of dividend growth that goes back to the early 2000s. In the years following the financial crisis Mondelez kept its dividend flat for a couple of years.

So, it all comes down to a choice for GIS, JNJ, KMB, SKT or VTR. Isn’t that a sweet problem?

What is on your buy list for the month of June?

Mental Models: Confirmation Bias

Two weeks ago I started the series My First Years of Investing in which I share my experiences and beginner mistakes. You can read the first article here, and the link to the second article is here. Before I dig into my motivation to start buying stocks of dividend growth companies, which will be the third part of this series, I wanted to elaborate more on the mental model of confirmation bias. The reason for this is that it has played a significant role in my decisions to buy, hold or sell a stock during my first years of investing. Those days haven’t been particularly successful. To say the least. At the same time I don’t really feel I bottomed this one out yet. I don’t control this recurring bias yet, it owns me. There’s still enough to reflect on in order to get a better understanding of this instinctive reflex.

“Remember this: the pain is all in your head. If you want to evolve, you need to go where the problems and the pain are. By confronting the pain, you will see more clearly the paradoxes and problems you face. Reflecting on them and resolving them will give you wisdom.”

– Ray Dalio

What’s This All About?

Confirmation bias is deeply rooted in our way of thinking and comes into play when we judge information on its relevance. It comes down to denying or rationalizing away the relevance, significance, or importance of opposing evidence and logical argument. Confirmation bias impacts how we gather information, but it also influences how we interpret it. We’re not mentally wired to have an open mind once we’ve taken a position on something, especially on emotionally significant issues. So, we all have our perspectives with its preconceived assumptions and unavoidable flaws which leads to biases. But the reason why confirmation bias has such a firm grasp on us is the elimination of a correction mechanism. It disconnects us with reality, or at least an opposing explanation of events or argumentation. The ground for critical thinking, doubt, suspicion and alternative views have been cut off. This is exactly the reason why confirmation bias will only get stronger with time and activity. I believe this works two ways. At one hand, confirmation bias make us to only select and order pleasing information that will be stored in our memory. You seem to be right so satisfaction guaranteed. I call this the one-time-event effect. There’s no reason to change our mode of reasoning. At the other hand, the confirmation bias is fed every time it processes affirmative information. Its base gets stronger, severe and more absolute. It has become a little bit harder to overcome. You could call this the stacking effect.

As confirmation bias has grown in magnitude with time and activity I believe it can only be broken by an event with an undeniable and painful impact. The reason for this is that under the usual circumstances of confirmation bias, the unpleasant new information can easily be ignored, denied or rationalized. Just like we always did. So, more is needed to open our eyes. That’s what they call a paradigm shift.

“This old truth is coming to an end.”

– Friedrich Nietzsche

Sorry, But What Does This Have To Do With Investing?

An important principle of value investing is you can’t time the market. Time in the market is better than timing the market. No one knows what the future holds. So we can’t tell whether we’re buying at the bottom. The advice to buy low and sell high is meaningless in this regard. We are only able to conclude if we bought a stock at a low price in hindsight. However, in hindsight nearly every mistake seems unnecessary and every investment success looks smooth. So, you really have to focus on the underlying fundamentals to determine whether a stock is trading at a low price and compare that to the intrinsic value of the business.

What really fascinates me, is at what point do you start to be wrong? I used to look at stock prices and thought declines of 30-40% or more are indicative. It’s only now that I see this is the wrong perspective. If you would like to know if you’re right or wrong about a company, you shouldn’t look at trading prices. It’s the core fundamentals that matter. To determine whether you’re right or wrong about a business, you have to know the contraview, which is the short thesis and track whether the fundamentals deteriorated. Is the company on its way down? But I didn’t search or read that information when I started investing in magic formula stocks or small growth companies. I didn’t do it at all. Not once. The section about risks in a long thesis didn’t even get the attention it deserved. I can see now that I was only interested in the upside. That’s one of the reasons I lost some of my money. I was only looking for supporting analysis or facts for the long position. You can think of insider buys, investors adding to their position or even investment pitches of years ago. Most of the times I bought more stocks without studying the fundamentals and analyzing for negative trends. A recipe for disaster, that’s for sure. You can see how confirmation bias is into play here. It really impacts how we gather information and how we neglect crucial information. This was a fundamental flaw in my decision-making process.

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When the share price of a stock I owned, went south for a while I was inclined to say: “See, value investing is not easy, I’m just being contrarian, Mr. Market is depressive again.” I justified my position in a stock with multiple quotes of famous and succesful investors and (unconsciously) made sure that the price movement was a confirmation of my opinion. But if the stock price increased I witnessed the long thesis playing out beautifully, I told myself I outsmarted everyone, and thought “I OWN Mr. Market. 😎” I just assumed my thesis was right and the moment I stepped in was spot-on. So whether the price went up or down, I was just right. Period. This is how confirmation bias influenced my way of interpreting information. I was in search for confirmation at all costs. No matter what happened. I even clung to the tiniest details of another bad quarter report of a magic formula stock or the second share issuance by a micro cap stock in a very short period of time.

Another one. Stock ownership by hedge fund managers was always an important check box for me when I invested in magic formula stocks. I always considered it because these guys are undoubtedly smarter than I am and have more time to analyze industries, companies and valuation multiples than I have. I thought, let them do the analysis and I invest a bit of my money in the same companies. Just driving shotgun, baby… But, so many hedge fund managers, so many positions. I focused on a handful in the beginning like Warren Buffett, Joel Greenblatt, Seth Klarman and Mohnish Pabrai. Later on I was also impressed by the track records of Leon Cooperman, Kenneth Fisher, Bill Ackman, Howard Marks and Ray Dalio. There was always an investing guru invested in a stock which had my interest. And if a hedge fund manager sold a stock I owned, there was always another big boy initiating a position in the same quarter. So my long thesis was always confirmed by one or an other one. Hey, they see value in this company. Let’s hold it, don’t sell yet. But at a lower price the same stock could offer a margin of safety. If the trading price of my stock collapsed with 50% over time, but the hedge fund manager stepped in at that low price he had a nice margin of safety if he analyzed the intrinsic value was 50% higher. Let’s assume he was right and that gap closed. Well, in that case he would have made a nice 50% gain. But with that increase in stock price I would still be down with 25%. So, it’s nonsense to find safety in guru ownership, especially at a much lower price.

“What should separate investors from speculators, Graham argued, was not what they chose to buy but how they chose it. At one price, any security could be a speculation; at another (lower) price, it became an investment. And in the hands of different people, the same security even at the same price—could be either a speculation or an investment, depending on how well they understood it and how honestly they assessed their own limitations.”

– Jason Zweig

What To Do, What To Do?

To erdicate confirmation bias I have to confront it right in the beginning. Otherwise it has a real chance to grow. Therefor it’s absolutely necessary to read the long and short thesis and pay no small attention to the risks of the long thesis. It’s also essential to focus on the underlying fundamentals of the business. I must be aware of my tendency to price-orientation. Another one is, stop rationalizing price swings as we’re better at rationalizing than at being rational. And last, but not least, don’t line up behind investing gurus. They’re often wrong and betting against eachother.

I want to finish this post with a wonderful and simple line by Jana Vembunarayanan from his post Self Deception and Denial:

Refusing to look at unpleasant facts doen’t make them disappear. Bad news that is true is better than good news that is wrong.

I really hope this post has offered you something to think about. Please feel free to comment.

Dividend Income May 2018

Well, here we are folks. This is the very first publication of my monthly dividend income. From now on I’ll be posting this information on a monthly basis to track my progress in reaching financial independence. Sharing this information publicly will motivate me even more to buy (new) dividend growth stocks and add them to my basket. I’ll be comparing my dividend income with the amount three months ago and the same month last year. Let’s roll!

The total amount of dividend income in the month of May was $153.68. In this month I got two raises for doing absolutely nothing more than in the month of February. Well, except for continuing to buy quality companies which have a nice streak of dividend increases. Apple increased their dividend with 16% and Tanger Factory Outlets paid me 2.2% more than last quarter. Tanger Factory Outlets became an official Dividend Aristocrat this month by paying a higher dividend than last year. That’s always nice for the statistics. Besides, in February I didn’t possess any stocks of Realty Income in contrary to the month of May. The dividend income was divided by:

Apple (AAP) – $16.06

CVS Caremark (CVS) – $2.00

Realty Income (O) – $3.72

Omega Healthcare (OHI) – $66.00

Tanger Factory Outlets (SKT) – $22.40

AT&T (T) – $43.50

This totals to an amount of $153.68. My dividend income in the month of February was $144.88 so that’s a very welcome increase of 6.1%.

My passive income in the month of May last year was $15.86 so that’s an increase of 869%. Say WHUT? Yes, a 869% increase! The difference comes from loading up the truck with various REIT stocks which have traded at very low valuations last year. This lead to very high dividend yields. REIT stocks have climbed out of the valley lows last weeks. If prices continue to increase; I’m good with that. In case of another price decline I may add to my position of Realty Income and Tanger Factory Outlets. So, according to me, there isn’t really a bad case scenario. During the month of May I also benefited from my nice position in AT&T which I’ve been building up quite conscientiously the last twelve months. The share price of this beaten down stock still looks very appealing.

This leads to the next graph:

29287E67-3EBA-46A3-820C-4DF33D6AFF45I already collected $636.10 this year whereas my total dividend income in 2017 was $827.81. We’re still in the first half year of 2018 so this looks very promising. As you can see I’m moving forward, every year, every month, and with every addition to my stock portfolio. That’s a good feeling. And, we’re already off for the month of June.

I’m very curious how you did this month. Please share your progress and insights.

My First Years of Investing, Part II

Dividend growth investing hasn’t always been my investment strategy; I tried different approaches of value investing to eventually reach my goal of financial independence. In my previous article I wrote about how I got to investing in the first place and my personal experiences with magic formula investing as thought up by Joel Greenblatt. After two years of disappointing investment returns and the awareness that I wasn’t on the right track I decided to do things differently.

Making Big Money Under The Radar… I Thought

As I wrote in my previous article I read hours and hours about investing. I regularly had read about micro and small cap stocks outperforming stocks of mid and large cap companies. This has many causes of which I’ll highlight two here. The outperformance of the stocks of micro and small cap businesses is primarily driven by their lack of visibility within the investment community, which leads to a disconnect between their stock prices and fundamentals. Investors can take advantage of this discrepancy. Another reason for their outperformance is stocks of micro caps and small caps are thinly traded. This presents a great opportunity. If the company survives the imminent struggle of being small in terms of market capitalization (like cashburn, loans with high interest, customer concentration) and becomes larger and profitable, analysts will start coverage which will attract more investors. The paper of O’Shaughnessy Asset Management Microcap as an Alternative to Private Equity highlights that 2.1 analysts only cover the typical micro cap stock on average. Some stocks aren’t even covered at all. If future growth prospects of these under the radar businesses remain solid, then demand for the stock inevitably perks up. But there’s only a very limited amount of stock which gives micro and small cap stocks the potential to rise substantially.

Partly based on the above mentioned reasons I decided to allocate more capital in micro and small cap stocks. I sold many positions with a net loss, but I told myself this was necessary. “Things will only get better from now.” Based on paid newsletters and analyses of authors on public websites who had made significant amounts of money (according to themselves) I invested more and more money in these companies. The investment pitches were more or less identical. Most often it was a very small company of which the CEO was the original founder who owned large piles of stocks. So the shareholder interests were aligned with the interests of the CEO. The business was cashflow negative but this would certainly change within 4 or 5 quarters. However, revenues and earnings were rising with growth numbers in the 30-50% range. The companies were one-trick ponies or sold lots of stuff but couldn’t manage the costs of growing this fast in such a short period of time. Hey, but that didn’t matter, because if they could get their gross margins under control, earnings would skyrocket. And if we just extrapolate those earnings to the future, then the company traded at very, very low multiples right now. So you better be quick…

Unnoticed Cognitive Bias

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Source: Better Humans

I went on a buying spree and ended up with stocks of companies like Crossroads Systems, Digirad, Glu Mobile, Inuvo, Musclepharm, Noble Roman’s, On Track Innovations, Perion Network, Spark Networks and SuperCom to name a few. My decision to buy stocks of these kind of companies was often based on analyses of two or three authors. In a couple of cases they wrote follow-up articles about events related to the companies such as quarter reports, winning or losing clients, tender offers and renewed bank credit facilities. The perspective was mostly biased; the quarter report was not as expected, but the bigger picture still looked great; although the company lost a client, the focus of management has shifted to the higher margin products/services; share dilution was significant due to issuing shares, but this created the opportunity to accelerate investing in business opportunities; the interest rate on the new credit facility agreement was in the high single digits, but working capital has improved for the better. My confirmation bias made me average down like crazy. “Wasn’t that going against the herd?” I told myself. During the first year I added to my positions vigorously when prices went down more than 20%. I had read extreme price swings were typical for investing in stocks of micro and small cap businesses. So this was all part of the game, it seemed. Besides, the beauty of averaging down is your loss in terms of percentage points drops. So that looks good. If prices increase, well, that makes up that annoying red-coloured amount of money in the column next to my loss in percentage points.

It wasn’t all drama. Some stocks were up 30%, others 80% or even 700%. Companies like IEH, Marathon Patent Group, Pacific Healthcare Organization for example, This investment strategy certainly works if you pick the right companies, but that’s always the case with hindsight bias; these are backward-looking figures. Regarding my positions in green, I got greedy… Some positions were down 40-50% and my big winners masked that loss on a total portfolio basis. It’s nice if that number isn’t down too much. And, if it’s up 700%, why couldn’t it double again or maybe triple if I’m lucky? I read multiple times you only have to find one or two homeruns to really make a lot of cash with investing in micro and small cap companies. So, I didn’t sell my golden eggs. But I didn’t buy more of them either on their way up as it was emotionally hard for me to add to my positions at higher prices. I just loved the profits of 100% and 700% up in price and I didn’t want to screw that charming sight. So anchoring bias certainly kicked in. At some moment I had invested my savings in 25 of these companies. I fortunately acknowledged that diversification is a good thing when buying these high risk, high reward stocks. At least, I was that smart.

But I found out soon that investing is not easy and certainly not the way I practiced it. The stock prices of micro caps and small caps tend to move independent of what the Dow Jones Index or NASDAQ does. I didn’t feel comfortable when stock markets were up and at the same time the prices of stocks I owned were down. On those days I browsed Internet and all kind of forums for explanations. “What causes this price decline? Do these sellers know something what I don’t know?” During my period of investing in small companies I was often searching for more information supporting the long thesis. I didn’t want to read the short thesis as I believed that would only bring doubts and jeopardise my investing success in the long run. To convince myself of the plausibility of being long and the need to standfast I reread the investment case over and over. (I tried so hard to apply some fundamental value investing principles.) But, it was just simple pain-avoiding psychological denial leading to self-deception: denying or rationalizing away the relevance, significance, or importance of opposing evidence and logical argument.

How It Turned Out

As I mentioned earlier I had built big positions in underperfoming stocks by averaging down and small positions in stocks which were up significantly. It took only one thing to let reality set in: major price declines of the stocks that had an incredible run-up. The stock which was up 700% decreased at least 90%, because the business lost a big customer in terms of revenues. Another stock crashed more than 80% due to disappointing growth figures. With time I sold positions of which it was impossible to justify them any longer. Realized losses within the range of 40-50% were normal. I still had confidence in some stocks that were down, but I sold almost all positions except maybe five stocks. These were high-quality companies with a good business model, diversified customer base, growing earnings, low debt and so forth. Now, some stocks I sold were up 20% and 50%. I think my total loss at the end of this period was around $4.000.

After three years of investing I felt pretty depressed. All I had to do was investing in good companies of which the metrics are publicly known and on various websites and buy their stocks at low prices which means only when the estimated value exceeds the stock price. Why is that so hard to do? All the big names are up around 20% a year and I can’t even generate 15% or at least 10% a year. And it has been a damn bull market for years now. LOSERRRRRRR! It looked like financial independence was completely out of reach. No apartment in Newport Beach and condo in San Diego for me, folks. Still, I refused to be a hack until my retirement age…

In the next part of this series I will set out how I came to dividend growth investing, my motivation to adopt this investment stategy and the things it has brought me.

My First Years of Investing, Part I

In my first article I wrote about my decision to start a blog and my purpose for investing: to achieve financial independence at the age of 55. I truly believe this is within reach if I consistently invest my savings in good dividend growth stocks at a low or reasonable valuation in the years to come. So this will take discipline; discipline to not spend my money on unnecessary things, but also discipline to take into consideration the valuation metrics of dividend growth stocks in my buy decisions.

But, dividend investing hasn’t always been my preferred investing strategy. In fact, I considered it a boring and ineffective way of investing when I started in 2013. I thought it would be insightful to share my last 5 years in investing, my investing results and the psychological aspects which made me decide to radically change my method for achieving financial independence. Hopefully, by reading these series you won’t have to learn some essential lessons in investing the hard way. Like I did. In a strange way, I can now fully reflect on my motivation and (in)decisions in the past. I believe this has only been possible because I’ve found peace of mind by investing in dividend growth stocks instead of chasing the hottest microcaps, hoping for price increases and calculating my returns.

I think it will be a three part series, but we’ll see if that will do.

A Great Idea Without Action Is Not Always A Regret

I’ve always been a guy spending his money. In another era you had physical objects like CDs and hardcopy books. Just like any other person in that epoch I bought a good amount of that stuff. I even liked the sight of CDs and books in my closet and did my best to solve the existential problem of how to archive all that stuff: books on author, age, topic? CDs on performer, music label, music style, era? Besides these cultural doings I also bought a ton of expensive Italian clothing items. I loved the craftmanship, materials and the idea of clothing like a gentilhomme. At the time of all these spending habits of mine (I was 26 at that time) the Stock Market Crash of 2008 set in. It was a horrorshow. Stocks prices fell like crazy. Also in my country, the Nerherlands, beloved stocks of companies like Royal Dutch Shell, Unilever and ING were on sale. A certain stock of a company in the banking and insurance business (I can’t remember its name) traded at prices of a pair of pennies. I still remember me telling my father that if I only had more money I would certainly have bought tens of thousands of stocks of that company, because last year it was selling for tenfold prices. At that time, I was really bummed that I didn’t have more money, because I truly believed that I would have made more than a 1000% return in maybe two, or three years. My father had some doubts about my presumption. He has this laugh, you know. Within a year the company was out of business…

The years after my overconfidence I regularly filled in some forms of online broker firms to open an account. At that time the stock TomTom (AMS: TOM2) had collapsed from €60+ prices in 2008 to €5 (it now trades for €8.50) in 2011-2012. I had often heard some colleagues in the pre-crisis years saying “you should buy TomTom”. This second occurence of a stock price gone south stopped me from opening an online brokerage account. It seemed like gambling. Nobody had foreseen these price movements. The case of TomTom was pretty simple. They sold user friendly navigation software & hardware in the price range of €250 to €400 a piece. It was a total package just like Garmin, everybody bought one. But with the launch of smartphones the only thing necessary for destroying their business model at those days was having an interactive digital map on your smartphone. As these smartphones got more and more capacities and turned into minicomputers, that was exactly what happened. Bye, bye business model. In hindsight, it’s no rocket science. But the smartphone was new, a truly disruptive product. Nobody saw it coming. So I hesitated for a longer period of time to buy stocks.

Things Are Getting Pretty Serious

In 2012 my oldest daughter was born, a true star. I had already transformed from a guy spending his money into a man saving his money to be able of taking care of my family. But, a new human life, totally dependent and pure, completely changed my thinking habits. I rethinked every expense before actually spending my money. Is it necessary? For whom is it necessary? Do I need the expensive version? Do I overpay? My material needs were gone. I saved every pennie I had. Sometimes I considered investing again, but that seemed too risky.

During the years before I subscribed to several newsletters about investing. One newsletter caught my attention. It was about value investing and Warren Buffett. The guy behind this newsletter had written a book about value investing and shared one chapter of that book with its subscribers for free. I read it and was stunned by the track records of the investors mentioned in the books: Benjamin Graham, Warren Buffett, Joel Greenblatt, Mohnish Pabrai and Seth Klarman. And in some way, these guys shared the same investing strategy. The shareholder returns of Joel Greenblatt stuck with me: his Gotham Capital had achieved 40% annualized returns over a period of 20 years, from 1986 to 2006 with only a small portfolio of 5 or 6 stocks. It also said something about his newest investing style: magic formula investing. I laid my hands on a digital version of Greenblatt’s book The Little Book that Beats the Market printed it and read it on the train on my way to work.

The simplicity and logic of Greenblatt’s magic formula for investing struck me. I remember staring out of the window and concluded that financial independence was suddenly within reach. A list of out of favor stocks are on the website http://www.magicformulainvesting.com so I didn’t have to calculate the earnings yield and return on capital by myself. The only thing I had to do was be patient; it’s what makes this formula unpopular, and therefor effective. So I started an online brokerage account at Interactive Brokers. At those days I also found a website called http://www.GuruFocus.com with detailed information about US companies and investments of all the big names I read about earlier. Man, I spent many hours a day reading articles and case studies, watching videos, browsing websites, printing stuff, archiving interesting information about companies. Texts which touched subjects of having a long term view, the short term orientation of hedge funds, the necessity of going against the herd and the concept of a margin of safety really resonated with me. So I thought I was ready for the job. And, I just couldn’t wait to buy my first stock.

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”

This expression is Charlie Munger’s. It’s why value investing will always work; people underestimate how difficult it is to stay focused, to not get carried away and to make sure that every action to buy, sell and do nothing is based on rational analysis and a thorough decision-making process. Psychological factors will challenge you: do not miss the boat or step out, it’s getting rough or my favourite act, the price is at a 52-week low. I read it, I read it all, but I was good in selecting quotes (sometimes twisting them a bit 😕) and justifying my buy and sell actions by those quotes. So, dying for action, I bought stocks of companies like Alaska Communications Systems, Alcoa, Apollo Exucation, Chesapeake Energy, Deckers Oudoor, Digital River, Exco Resources, ITT Educations, J2 Global, J.C. Penney, Kronos Worldwide, Sears, Tempur Sealy International and so many others. In practice, my rationale to buy a stock came down to:

1) Is the company on the list of magic formula stocks?

2) Has a big name in the investing world a stake in this company?

3) Can I step in around the same price as the big investor had paid?

Sure, I also looked at the metrics of Return on Assets, Return on Capital, Debt-to-Equity ratio, Free Cash Flow and so forth. But eventually, I bought stakes in companies because a well-known investor had also invested money in these businesses and who am I to doubt them and their analysis? Hey, and the stocks certainly were out-of-favor. No doubt about that. Prices had fallen because of declining sales, falling earnings, shrinking margins, increasing pressure of government regulation and heavy debt loads for example. Life was simple back then (pun intended): if prices increased I was right and if prices fell I was offered a great opportunity to average down. And if the stock really crashed, this big investor turned out to be a [BLEEP]. I would describe my first year and a half as Buy High, Sell Low. Three or four times a day I checked the price action of the stocks I held in my portfolio. I watched the 52-week low stocks for new ideas and checked the stocks that sold for 52-week high prices for learning which shares I should have bought. Price movements of the markets in general and the shares I owned, determined my mood. Because of my poor investments returns I got short-tempered and grumpy. I wasn’t a nice person back then. This couldn’t continue so after a while I decided to change my investing strategy.

In part II of this series I will cover my second investing strategy, my investment results and the misalignment between this strategy and my character. It wasn’t a succesful period…

Latest purchase: PepsiCo

05E07AE7-EBAE-430F-9826-ED59387D0C05Today I purchased 9 stocks of PepsiCo (NYSE: PEP). I have tracked the price for some months and didn’t want to step in for a price around $110. Mr. Market got more depressed the last couple of weeks as food and beverage companies in general have fallen out of favor, and offered this great company for sub $100 prices. As expected, I waited too long (again) and got in at still a fair price of $100.45 (including transaction fee). I was eager to own a stake in this business as it’s always nice to add a dividend aristocrat to your basket of dividend paying companies.

PepsiCo has been on my watchlist for the last two years. It’s a great company with 22 $1B brands! It has a glotbal footprint in over 200 countries. PepsiCo has a nice diversified portfolio of food and beverage products like Pepsi (Ah, I see), Gatorade, Quaker, Tropicana, Frito-Lay and much more. Their record of increasing their dividends for 46 years in a row is a proof of their sustainable business model and ability to generate free cash flow. PepsiCo continues to expect $7B in free cash flow for the full fiscal year. Their competitor Coca-Cola (NYSE: KO) has a mythical status; their brand recognition and marketing machine are exceptional (holidays are coming, holidays are coming…). Besides, uncle Warren made loads of money investing in this business. But their future shareholder returns do look a bit mediocre as compared to PepsiCo, imho. As consumer demand continues to shift towards nutritious products, PepsiCo is responding by improving the nutritional profile of many of its products by reducing sodium, added sugars and saturated fat. Pepsi also shifted their focus to the higher growth, higher margin snacks category, which should drive solid corporate results despite beverage market share weakness in general.

At the time of purchase the stock traded for a P/E of 17.5 (EPS based on the estimates of analysts for 2018). I usually wait for a lower P/E metric, say in the 15-16 range. But as always quality comes with a price. Besides, I really try to see my purchases in the bigger picture: “Does it really matter if I pay 15 or 17 times earnings for a share in a great business when my holding period is forever?” In case of a further stock price decline, I’ll gladly add more PepsiCo stocks in my beloved basket.

At the P/E ratio of 17.5, I locked in a forward dividend yield of 3.71%. They’re paying me $0.9275 per quarter. So 9 shares totals to $33.39 on a yearly basis. Not bad, not bad at all. I have to say that I’d like to buy/add stocks to my portfolio at a 4+% yield. But, I’ll get around that number if the stock price may fall further. So this is a good starting position.

As I wrote earlier, PepsiCo has rewarded their shareholders for quite a number of years. They’ve increased their dividends for 46 years in a row. Let that sink in. A continuous dividend increase since 1973. Elvis was still alive back then! You’d expect that the dividend growth rate may slow down, but after increasing their dividend with a 7-10% increase for the last 5 years, they increased it with a whopping 15.2% from their prior dividend of $0.805. This stresses the confidence of management in the resilience of their business model.

The dividend payout ratio based on analysts consensus of earnings in 2018 comes down to 65%. This is a reasonable percentage for a company with a resilient business model selling multiple A-products. I certainly don’t expect multiple 10+% increases in a row from now on. Increases of 7% would do it for me.

GuruFocus states that PepsiCo’s highest Return on Capital (Joel Greenblatt) was 69.25%. The current Return on Capital sits around 63.32% so this company surely knows how to create value. Their RoC is even ranked higher than 90% of the 102 companies in the global industry!

The company announced in February a new stock repurchase program up to $15B common stock commencing on July 1, 2018, which will replace the $12B repurchase program that is scheduled to expire on June 30, 2018. The market cap of PepsiCo is around $142B so the addition equates to more than 2%. Nice!