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…