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Why do I analyze dividend stocks that are not buys?
Posted by: Dividend Growth Investor (IP Logged)
Date: June 4, 2013 08:01AM

I have the terrible habit of analyzing companies that I never plan on investing into. While I do try to focus on the best dividend stocks in order to generate a rising dividend income for life, I sometimes focus on companies which are not good enough for me. I believe that it is great to learn all there is about the best dividend stocks, how they make money and what gives them competitive advantages. However, I have found that I learn even more about what I want to see in a successful company, by looking at companies that are not very good.

For every dividend growth investor, making money is very important. However, it is equally important that I avoid losing money whenever possible. Losing money on a few investments is bound to happen, as not every dividend stock will perform according to plan. If on average, 30% of the investments I make deliver growing income and total returns in the process, then I will be a happy camper. The rest will be either get acquired, generate slow growth or deteriorate over time and even fail. I am perfectly fine missing out the next McDonald’s (MCD), if that means that I will miss out on the next Enron or Lehman Brothers. The main idea is that in order to win, one has to learn not to lose too much. Another important factor is learning as much as possible about investing and shaping these ideas into a unique strategy that pays dividends.

This thinking was directly plagiarized from Warren Buffett’s famous quote” Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.”

For example, I am not a big fan of technology companies. There are a few such as Intel (INTC) or Microsoft (MSFT), which have raised dividends over the past decade. However, I am not confident about their ability to generate growing earnings to support future dividend increases. These companies have solid competitive advantages today, but given the rapid changes in technology and computing, they could be offering an obsolete product 10 – 15 years down the road. As a rule, I tend to ignore investing in companies which I cannot reasonably foresee selling the same type of product or service in a decade or two. What is really keeping executives at Intel and Microsoft at night is the possibility that a guy is currently working in a garage, creating the next big disruptive technology that could potentially take these firms out of business. I see the risks of some guy in a garage creating the next brand of Tylenol or Gillette shaving products remote, which is why I sleep well at night.

However, I have found that companies that rely on technology to serve their customers and build relationships with them in the process can build long-lasting business relationships with them. This can lead to a strong competitive advantage. A publicly traded company typically keeps its auditors or legal firm for decades. Too bad law and accounting firms are not publicly traded. The firms also use consultants such as IBM (IBM) or Accenture (ACN), which have built a strong relationship with it. Small and Medium Sized companies utilize the service of outside payroll processors such as Automatic Data Processing (ADP) or Paychex (PAYX), which have strong competitive advantages. Companies are less likely to switch to another payroll processor, given the headaches this is associated with. As a result, ADP builds lifetime business relationships, and benefits from decreasing costs in technology and through its scale of operations.

I am also not a big fan of multi-level marketing companies. I analyzed NuSkin Enterprises (NUS) a few weeks ago, and determined that I was unable to see any competitive advantages that it held. This was despite the fact that financials looked very well at a first glance. In my early days of investing, I might have purchased a company’s stock simply because its financials looked good. As I gained more experience however, I have taken a deeper dive into the qualitative side of the business, in order to understand how the company makes money. This is important, because it helps me visualize whether the company can still make money one or two decades from now, and grow profits and dividends in the process.

I was particularly turned off by NuSkin because they had restrictions about selling its products in stores. If you are a business with a legitimate product, you want to be able to sell it in as many venues as possible. If you limit your distributors from displaying products in their stores, this is a red flag that raises questions about the products sold and makes me question the viability of the whole business model. I do like companies like Procter & Gamble (PG) however, which provide a globally diversified portfolio of products to as many customers in the world as possible. Once your consumer start shaving with Gillette products, they would likely continue doing so for decades to come. P&G continuously invests in building the brand, and innovating products to make them better and more profitable.

Full Disclosure: Long ADP, PG, MCD, IBM


Stocks Discussed: ADP, PG, MCD, IBM, INTC,
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