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Why I Invest in the Stock Market the WAY I DO?????? January 23, 2014

Posted by shaferfinancial in Finance, Uncategorized.
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There is much out there about how to invest in the stock market. Most of the advice has proven to be really bad. I researched this extensively back in the 1990s well before the current issues with commonly advised strategies were apparent. Nothing that has happened since then in either the market or my personal investing has made me change that conclusion. In fact, as soon as I changed my strategies, my rates of return dramatically increased. Note: this is about how I invest and should not be considered advice as to investing in any particular stock.

My main realization was that investing in mutual funds as a single strategy was a losing proposition. Can anyone that actually looks at the data on individual’s investing doubt this? Both from an individual psychological perspective as well as a pure numbers perspective this strategy is a loser. I understand the propaganda is strong, but really anyone can look at the data of investor performance over the last 20 years and see the failure.

My next realization is that one could, with some basic financial understanding, get to know companies and their books well enough to make some decisions on what kind of company it is and how well they are doing. This is Warren Buffett’s basic premise; Look at the companies first, management, what they do, how well they have done it, whether they have some moat to their business, etc. Those that follow this premise do well, those that don’t….well just speculate. Buffett goes on to point out that for those that don’t want to actually look at companies it is best to just invest in a cheap index fund and plan on a rising tide raising all boats. For me, I look at what he does [and he admits it is not high math] and figure that for what he charges I can afford to have him invest for me.

So that was my first realization and still have 60% of my portfolio riding with Warren.

My second realization is that I was investing for retirement income, not some value that could be turned into income. So, in addition to my Berkshire Investment I needed to use a set of strategies that would give me income. There are 2 main strategies that historically has demonstrated the ability to build income. Real Estate and dividend producing equities. I started off doing both, but have found for me that the latter seems to work better [even though for most I believe real estate would be the better choice]. So, even though I do both of these, I mostly develop my dividend producing portfolio. As you now know, that is 40% of my overall stock portfolio.

I started off dividend investing in a REIT [HCN] to go along with my Berkshire Hathaway. Following Buffett’s and others advice I bought shares of HCN whenever I had the cash AND the market was undervaluing it IMO. Because I was mostly purchasing HCN when the yield went over 6% and they were increasing dividends on a regular basis, my yield on cost is now over 15% on my shares. This is not an example of my superior ability, but of just following a strategy that has proven to work [Buffett bought several positions in his portfolio that have over 100% yield on cost]. You will find several sites on the internet where the authors have better results than me for their portfolio, so once again it is the strategy not the stock picker that is important here.

Buffett also stated that it was better to not diversify broadly because why buy your 20th best idea instead of sticking with your absolutely best ideas. Again, Buffett started [and remains as much as possible] with a concentrated portfolio. So for a long while I owned two stocks [85% or so in BRK and the remaining in HCN. But here is an important point; I understood these two businesses well, paid close attention to the details of both the business and the global economy in which they operate.

Then came the great recession and I found a little known energy stock that had been beaten down [MMP]. They were a midstream oil company meaning they transported oil and gas from the drillers and refineries to the end users. Much of their revenues was protected by the tariff system and they were growing smartly despite the stock markets opinion of them. I bought when the dividend yield was 8-9% in 2008-2009. It wan another Buffett pearl of wisdom about buying when there was blood in the streets. As we clawed our way out of the recession their revenues and dividends increased smartly and by the time I sold the shares in 2013 for triple what I had paid for them, my yield on cost was around 15%. The only reason I sold this was because it had become severely over valued by the market [in my analysis] and I could trade ownership of a stock that was yielding 4.3% with stocks that yielded significantly more and were undervalued in my analysis.

Now I am not perfect and want to describe some buys and sells that showed undisciplined behavior that was not in line with my established strategy. Some worked out and some didn’t.
I call this the “story” stocks because I fell in love with the story but didn’t attend to the fundamentals of what the companies were really about.

I had a friend working for a high tech company going IPO and she put us on the friends and family list. We got in to that IPO and 2 months later sold for a hefty profit. I knew that it was unlikely to hold its value because it was really a company with 1 product that could be surpassed at any time by competition so I got out before the enviable happened and it dropped in price significantly eventually to be bought out by a bigger company. That was a success, but more about luck of timing and friendship than anything else. I took that money and invested in an on-line mortgage company in California. This was before all the on-line companies we now know were around and since I was in the mortgage business I though this was a pretty good idea. They had some good managers, but when I purchased little in revenues and big losses. This did not turn around and soon the stock started dropping like rock. I got out, but not before I had lost all the profits I made from the friends and family purchase and then some. Lesson learned there, never will I be involved in investing in a company with no profits again.

I have also owned stock in a small bank that my wife worked at. The first couple of years the stock went up dramatically. However after she left the bank, I stopped paying close attention. Leading up to the recession their profits stopped [like a lot of banks] and the stock started to drop. Because I wasn’t paying attention it was 6 months before I realized the fundamentals changed and by then it had dropped 75%!
Lesson learned; pay attention!

Last year I bought two stocks because of the stories and I thought the fundamentals were adequate. But they did not have a strong history of dividend payments and their future products that I thought would push them forward were new to the market. I went on vacation for the entire summer and during that vacation came to my senses about how those stocks didn’t fit into my strategy of stock ownership. Fortunately, both companies stocks went up double figures during the summer and with the dividends I got showed around 15% profit in my short ownership [they have both gone down to around my purchase price since then]. I think lady luck was with me on those two too! The lesson learned was not to fall in love with a story, and again pay attention to how the current products are doing, not what some imagined product might do in the future. The other lesson learned is if you want to take chances a bull market is the time to do it! Lots of margin for mistakes.

I had been reevaluating my ownership in HCN for a couple of years because the dividends were only rising 3% annually on average. Even though I still liked the fundamentals, the management, the products, the strategy, I need dividends to increase faster than that in order to reach my dividend income goals. So I sold a minority of my position when the stock seemed a little overvalued this summer. It has since dropped about 12%. I wish I would have sold a larger chunk back then, but I think the price will come back up this coming year and provide more opportunity to sell. If it doesn’t I am still getting a 5% dividend [over 15% yield on my cost] and it is still growing, albeit slowly.

Finally, I have purchased several high dividend energy companies of late. I did ample research into these 3 companies and feel comfortable with their business models, that their product is and will be in great demand and that their management teams are top notch. My yield on cost for these three are 11%, 8% and 20% [the order is the same as the percentage in my portfolio with the 20% yielder being the smallest percentage of my portfolio]. The prices have gone up a little, then down, then up and now down a little meaning they are basically exactly where I purchased them. But, that doesn’t really matter to me. I am looking at the dividends they are paying and 2 out of the 3 have increased dividends in the short time I have owned them.

NOTE: All my moves after 2007 are recorded in this blog for all to see and judge. I go into much more detail about all my stocks I own and sell in various blog posts.

Just one more comment. I do have other income producing investments [EIUL, Real Estate] that complement my dividend producing stocks but those go beyond the scope of this post. They both have significant tax reduction strategies accorded them which is the other piece of the puzzle I haven’t gone into with this post.

Postscript: Found this link from one of my readers. Thought you all would like it. http://maassinnovations.wordpress.com/2013/12/07/now-this-is-a-surprise/

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Comments»

1. Joshua Andrews - January 24, 2014

This was one of your best posts of all time, thanks for sharing!

2. James Pratt - January 28, 2014

DITTO:)


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