Dividend Income June 2018 “What Happened?”

It’s that time of the month again. ☺️ This is only the second time I’m publishing my monthly dividend income and I have to say I already like these regular posts very much. The DGI community reaches out to eachother to read, learn and motivate. My blog is a success already as it gives me the opportunity to communicate with so many people around the world who are in the same boat. It’s so cool! And it motivates me even more to buy (new) dividend growth stocks to only see the snowball effect getting bigger and bigger with time. Just like we want it. Last month my dividend income grew 869% YoY. Let’s see how I did this month.

Dividend Income & Two Increases

The amount of dividend income for June was $127.26. In this month I got two raises as compared to the dividend payment three months ago. Southern Company gave me a nice raise of their dividend with 3.45%. They have a respectful streak of growing their dividends for 16 years. Exxon Mobil paid me 6.49% more than last quarter which was their 35th time increasing their annual dividend. Wow! I’m very pleased with the increase of this Big Oil company after a lower growth rate during the last couple of years. This month excluded dividend payments by the companies ConocoPhilips, IBM, Wells Fargo and Walmart as I sold these positions at the end of 2017 and at the start of 2018. ConocoPhilips paid me $2.28 back in April, whereas IBM, Wells Fargo and Walmart respectively contributed $19.50, $14.82 and $12.75 to my quarterly dividend income.

In June I bought 27 stocks of Starbucks for a price of $54.00. The stock currently trades for about $48 a share, which equals an all-time high of 3% dividend for this company. In the coming days I’ll probably buy another bunch in order to average up my yield on cost. If management sustains the 20% dividend increases a year for the coming two years, then stepping in at a price of $48 will result in a yield on cost of 4.3% in 2020. Surreal!

Selling IBM, Wells Fargo & Walmart

My positions in IBM and Wells Fargo were partially based on Warren Buffett owning large stakes in these companies. When I first bought IBM in 2015 I thought they would hit back in two or three years after finding a formula for monetizing Watson and their big patent portfolio. I was convinced IBM was a regular turnaround story so I built up a nice position in two years. Reality set in when the Oracle of Omaha sold a part of his IBM position for Berkshire Hathaway. Only then I realized that margins would stay under pressure for a longer period of time because of increased competition by more successful competitors in the cloud computing business like Amazon, Apple, Google and Microsoft. Their most recent dividend increase showed a lower growth rate than the years before. So after that announcement I sold my entire position in IBM.

The story of Wells Fargo is more or less the same; I sold my shares because of a slower dividend growth rate. I built my position during two years. It used to be a terrific company, a bit boring, but a steady deliverer. But the stock tanked when Wells Fargo announced they had discovered millions of fake bank and credit card accounts. This is a company which will do fine sooner or later, but I didn’t feel comfortable owning it any longer. In fact, the other day I read Wells Fargo announced an increase of their quarterly dividend with 10%. So they may be already on their way back.

I sold Walmart after the sales and earnings numbers of the fourth quarter of 2017 showed pressured margins and deceleration in e-commerce sales growth. The company increased their dividend with only 2%. At that period in time, Mr. Market offered better alternatives in terms of dividend yield, growth prospects and valuation.

Now, I didn’t sell these positions with a loss, but I surely missed out big wins with Apple, Boeing and JP Morgan as these were the companies I considered as an alternative back then. So my loss is actually the missed compounding of investment in those businesses. Boeing is already a triple and JP Morgan a double as compared to the price levels at which I decided not to buy these stocks but IBM, WFC and WMT. These flawed investments show how important it is to have a smart buy strategy. The oppprtunity costs can be huge.

Breakdown of Dividend Income YoY

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My passive income in the month of June last year was $110.30 so that’s an increase of more than 15%. I know that isn’t close to the YoY dividend growth of 869% for the month of May. But when building a dividend growth stock portfolio you happen to have months that grow bigger and faster than others. A dividend growth of 15% YoY is still solid considering the shake up of my portfolio. You can see the loss of the above mentioned dividend payments has nearly been compensated by the quarterly dividend of DAL, O, PEP, SO and XOM. In June I benefited nicely from my position in XOM which I’ve been building up quite consistently the last three years. The share prices of DAL, O, SO and XOM still look attractive these days.

The dividend income for the month of June leads to the next graph:

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My dividend income in the month of March was $130.14 so that’s a decrease of 2.2%. I really don’t like a setback, but sometimes you need to step back and re-assess your portfolio. In contrary, I’m more than pleased that all months of 2018 show a steady upward dividend income in comparison with the same months last year. I really hope the QoQ growth number for September 2018 will be higher than my $127.26 for this month.

Dividend Income FY2018

We are halfway 2018 so the total dividend amount for the first six months is a good indication where I’m heading for this year. I already collected $763.35 this year whereas my total dividend income in 2017 was $827.81. It’s truly inspiring to foresee that the total YoY growth number will be amazing for 2018. The snowball is still rolling. That’s for sure.

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

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Recent purchase: Starbucks

 

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Wow, I didn’t see this one coming! Last week I wrote about a handful of businesses which were high on my conviction list: GIS, JNJ, KMB, SKT and VTR. I was pretty sure JNJ would become my next purchase.

But quite unexpectedly, the stock price of Starbucks came down with more than 9% on the day after its management announced a 1% growth in comparable store sales globally in Q3 FY18 instead of the previous growth numbers of 3%. Starbucks also laid out their strategic priorities and operational initiatives to accelerate growth and create long-term shareholder value. Besides a slower pace of licensed stores openings and closure of underperforming company-operated stores in densely populated areas, management announced an increase of its quarterly dividend to $0.36/share from $0.30/share and expects to return $25B to shareholders via buybacks and dividends through FY20, up from a prior target of $15B. The steep dive of its stock price and 20% increase of their quarterly dividend made me initiate a position in Starbucks.

The business

Starbucks really doesn’t need an introduction here as it’s the largest and most well-known coffee business in the world. Their culture and business model have made them a very succesful corporation in less than 50 years. It’s a fully vertically integrated business controlling much of their supply chain, from source (growing beans) to manufacturing (roasting the beans) and sales (retail stores).

The funny thing is I don’t like coffee. I don’t like it at all ☺️. In my country, the Netherlands, Starbucks still has a relatively small footprint. But wherever I see a location of Starbucks I always notice the atmosphere in their stores of putting the customers’ feeling and experience at the top of priority. I found out only recently that CEO Howard Schultz stated he wanted Starbucks to be a “place for conversation and a sense of community. A third place between work and home” (Starbucks Company Information). Schultz summarized this concept in nearly the same wording in an interview: “We’re in the business of human connection and humanity, creating communities in a third place between home and work” (Pelley, 2006).

The company clearly uses its corporate social responsibility as a way of distinguishing itself from competitors; they’re focusing on protecting the environment and encouraging fair-trade. Starbucks branding is essential for their success as their in-store experience of customer focus generates customer loyalty which creates some kind of barriers against competition. Starbucks doesn’t advertise as it wants to stay out of regular marketing methods and let the customer experience speak for itself. By doing this, they try to uphold the status of being an upscale company.

Starbucks’ differentiation technique is high quality coffee and excellent service, but customers started shifting towards cheaper alternatives of direct competitors McDonalds or Costa coffee where they got similar services. As a consequence its net margins have declined in recent years from 14.39% in 2015 to 12.89% in 2017. That’s clearly a worrisome sign, but gaining the global brand recognition of Starbucks isn’t an easy thing to do, would take a very long time and demand a major financial undertaking. That’s why the price came down significantly this week: “has their business model come under pressure?”

China has a legendary tea-drinking culture that goes back thousands of years. However, coffee consumption in China has nearly tripled in the past four years, with imports of coffee growing 16% a year compared to about 2% in the U.S., according to the International Coffee Organization and the U.S. Department of Agriculture. An average person in mainland China consumes just three cups of coffee per year compared to 250 cups per person in the U.K. and 363 cups in the U.S., according to Euromonitor International. The growth figures and potential are staggering especially in some large cities like Beijing, Guangzhou and Shanghai. Starbucks relies heavily on China as one of their long-term growth markets besides the U.S. The Starbucks’ China/Asia Pacific segment is growing like crazy with revenues up 54% to $1.2 billion in the second quarter. Urbanization and industrialization will remain big societal factors in China and will thrive their economy. Consuming Western products is a luxury fashion statement for the rapidly growing middle class and millenials in particular. So Starbucks is just spot-on with their strategy of aggresively growing the footprint of company owned stores in China. There’s a huge potential.

The purchase

I have to say that I was a bit early for the show and bought 27 shares for the price of exactly $54 a piece (including transaction fee) on Wednesday, the 20th of June. That equals to a forward P/E of 22.5. I hesitated to buy two chunks of smaller amounts, but unfortunately I didn’t. The price ultimately declined to around $50 a share. I’m confident with this P/E number as growth prospects for the longer term are still intact. I preyed for this stock quite a time and felt excited stepping in.

At the P/E ratio of 22.5, I closed in a forward dividend yield of 2.67%. They’re paying me $0.36 per quarter. So 27 shares totals to $38.88 on a yearly basis. This is definitely below my preferred step-in yield of 4%, but the dividend growth and payout ratio are phenomenal. Hopefully, market expectations stay depressed for a longer period of time which would give me the opportunity to double down on this one. I read fellow investors expected the stock price to continue its decline in the short-term towards prices around $48. I really hope so, instead of analyst firms making recommendations to buy or hold shares. Starbucks’ dividend yield is already at an all-time high, but a price of $48 would mean doubling down on a dividend yield of exactly 3%. “Where can I sign, sir?

Starbucks has increased their quarterly dividend for 7 years in a row. That’s not a hell of a streak, but I’m convinced their shareholders rewards program will lean heavily on increasing their quarterly dividend in the future. They would become a dividend contender by then and that’s the first line to cross for getting credibility as a dividend growth stock. The most recent 20% increase is in line with previous ones; the 5 year dividend growth rate is in the 20-25% range. Applying the 72-rule means increasing the dividend annually with 20% will result in a double in just 3.5 years. Sweet! In fact, the 5-year yield on cost of Starbucks sits around 6.60% at the moment which is ranked higher than 99% of the 398 companies in the restaurants industry according to GuruFocus.

The dividend payout ratio based on analysts consensus of earnings of $2.66 in 2019 and a ftm dividend of $1.44 comes down to 54%. This gives the company enough opportunities to continue increasing their dividends in the future. Add in the prospective stock buybacks and a consensus average earnings growth rate of 14% as expected by analysts and you have to conclude we’re into something good.

GuruFocus states that Starbucks highest return on capital (Joel Greenblatt) was 121.97% which equals the current return on capital. These numbers are beyond comprehension. This is surely a good business as it creates tremendous value for its shareholders. Their RoC is even ranked higher than 93% of the 332 companies in the global industry!

The company announced an addition of $10B to their shareholder returns program in cash and share buybacks, up from its $15B for FY20. That’s more than 33% of the company’s market capitalization. Nice!

Well, that’s it. Adding a good business with a high dividend growth rate and tremendous business growth prospects doesn’t seem a bad thing to do. I like to end with a nice quote of Howard Schultz: “We’re not in the coffee business serving people, we’re in the people business serving coffee.”

What did you buy lately and have you considered buying shares of Starbucks?

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 Increased 869% YoY

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:

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I 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.