1. How and why did you get started investing? What is your background?
When I went to college I chose a finance degree over a psychology degree, narrowly. There was one specific class I took in college about market inefficiencies – it covered how small cap stocks have historically outperformed, how value stocks have historically outperformed and so on. The idea of market inefficiencies really hooked me, and I’ve been deeply interested in finance ever since.
2. Describe your investing strategy and portfolio organization. What valuation methods do you use? Where do you get your investing ideas from?
My investing strategy is to invest in high quality dividend growth stocks trading at fair or better prices and hold them for the long run.
I get my investment ideas by looking for stocks with 25-plus years of steady or rising dividends. Any business that passes this hurdle has proven it can grow (or at least survive) over a wide range of economic conditions. From there, I use The 8 Rules of Dividend Investing to rank these stocks.
For valuation methods, I primarily use the price-earnings (P/E) ratio. The P/E ratio is used over other metrics because it is useful in comparing across industries as well as within them. You can’t use EBIT/EV – as an example – to compare if an insurance stock is cheaper than a manufacturing company.
3. What drew you to that specific strategy? If you only had three valuation metrics, what would they be?
I invest in high quality dividend growth stocks for the long run for three primary reasons:
- High quality dividend growth stocks have historically outperformed the market. You can look at the historical performance of the Dividend AristocratsÂ as well as many other studies to see this.
- Investing for the long run minimizes frictional costs. You don’t have to pay capital gains taxes when you don’t sell. You also minimize slippage and transaction costs when your holding period is measured in years instead of months. These minor gains add up over time. Additionally, when you invest in individual stocks, you don’t pay any management fees.
- The time it takes to invest in high quality dividend growth stocks is significantly less because you don't need to sell often.Â This way you don’t have to constantly come up with new ideas – which often aren’t as good as your previous best ideas. In this way, dividend growth investing is uniquely suited for the "regular" investor versus other effective investing methods like value investing.
As for my three favorite valuation metrics, the first is certainly the P/E ratio as mentioned in question 2 above. I should also add that adjusted earningsÂ are preferred as you want to show the true underlying earnings power of the business.
As a dividend investor, dividend yield is important as well, but it certainly shouldn’t be the only valuation metric you look at.
Finally, a valuation metric that takes into account the growth prospects and safety of the business is a great choice as well. Using the PEG ratio (price to earnings to growth), popularized by Peter Lynch, is a solid choice for this. The PEG ratio should be adjusted slightly – dividend yield should be added to the growth rate to come up with the G in the PEG ratio. This makes it a total return calculation rather than strictly a growth calculation.
4. Which books or other investors changed the way you think, inspired you or mentored you? What is the most important lesson learned from them? Which investors do you follow today?
My favorite investing book is "Quantitative Value" by Wes Gray and Tobias Carlisle. It takes a numbers-based approach to value investing and investing in quality stocks. It’s a fascinating read.
I’ve read more investing books than is probably healthy and learned from all of them. There’s almost always at least a bit of wisdom to be gained from reading the best thoughts of talented investors. Another of my favorites is "The Single Best Investment" by Lowell Miller. It discusses dividend growth investing in great detail.
And of course, following Warren Buffett (Trades, Portfolio)’s annual reports and investment methodology is another great place to learn. Buffett’s investment strategy is to invest in great businesses trading at fair or better prices for the long run, which is very similar to the goals of dividend growth investing. Buffett’s portfolio is full of high quality dividend growth stocks.
5. How long will you hold a stock and why? How long does it take to know if you are right or wrong on a stock?
I hold stocks for as long as they pay steady or rising dividends, and/or trade under an adjusted P/E ratio of 40.
Said another way, I will only sell if a stock no longer does what I purchased it for – that is to pay steady or rising dividends. Additionally, I will sell if a stock becomes extremely overvalued as its returns in the future are too heavily discounted by today’s irrational valuation.
You know you are wrong when the dividend is cut or eliminated. Hopefully, that is never.
6. How has your investing approach changed over the years?
It has changed a great deal. I started out as primarily a value investor. The idea of buying "50-cent dollars" really appealed to me. Over time, I’ve focused more on quality and long-term holding, and less on buying the deepest value stocks.
7. Name some of the things that you do or believe that other investors do not.
I believe most investors don’t invest for the long run, and don’t think about what will trigger a sell for them. This lack of discipline will likely result in much higher investing fees and too much portfolio churn. The mindset of investing in something potentially forever – as an actual owner in the company – is a lot different than investing in a stock ticker because you hope it will go up in a week.
8. What are some of your favorite companies, brands or even CEOs? What do you think are some of the most well run companies? How do you judge the quality of the management?
One of the most well run companies I’ve come across from a capital allocation standpoint is Philip Morris (PM, Financial). The company’s management has been exceptional at rewarding shareholders despite being in a slowly declining industry. An example of this from a year or two ago is the company issuing debt with a lower interest rate than the dividend yield on its shares (at the time). It used the proceeds of the debt to repurchase shares, simultaneously increasing the value of each share andÂ reducing the amount of cash the company paid out.
9. Do you use any stock screeners? What are some efficient methods to find undervalued businesses apart from screeners?
GuruFocus, of course, has a great stock screener. Another one of my favorites is Finviz for quickly screening stocks.
Another way to quickly find high quality dividend growth stocks is to look into lists like the Dividend Aristocrats, Dividend Kings, or Dividend Achievers, which have 25-plus, 50-plus, and 10-plus years of consecutive dividend growth.
10. Name some of the traits that a company must have for you to invest in it, such as dividends. What does a high quality company look like to you and what does a bad investment look like? Talk about what the ideal company to invest in would look like, even if it does not exist.
I look for a long streak of steady or rising dividends to prove that a company has a strong and durable competitive advantage.
A high quality company is one that has a strong competitive advantage and a shareholder friendly management adept at capital allocation.
A bad investment is going to be a company that is unproven and not yet producing consistent earnings. There’s too much risk there, especially with a high valuation. A lot of "market darlings" fit this bill – stocks that trade for enormous price-sales (P/S) ratios and don’t have real earnings. The value of the company is all potential.
The ideal investment will have:
- A very low P/E ratio and high dividend yield.
- Solid growth potential in excess of market averages.
- An obvious, strong and defensible competitive advantage.
- A corporate management that allocates capital well.
11. What kind of checklist or homework do you utilize when investing? Do you have a specific approach, structure, process that you use? Or do you have any hard cut rules?
Yes, as mentioned before, I use The 8 Rules of Dividend Investing to simplify the investing process. A quantitative approach minimizes the amount of behavior errors one can make when investing.
12. Before making an investment, what kind of research do you do and where do you go for the information? Do you talk to management?
Sure Dividend takes a quantitative approach. I don’t call managements specifically. Instead, we let the company’s history speak for itself.
For the information, my favorite sources are company quarterly and annual reports, and Value Line. Guru Focus is another excellent source.
13. How do you go about valuing a stock and how do you decide how you are going to value a specific stock? When is cheap not cheap?
My "back of the envelope" valuation method is to take the average P/E ratio over the last decade and use that as a baseline P/E ratio. Multiply this by trailing 12 months adjusted earnings to get a ballpark "fair value." From there, additional adjustments may have to be made depending on a variety of factors.
Cheap is not cheap when you are buying a failing business. No one can see the future. We all make mistakes. If you are buying into a company that is absurdly cheap, there’s usually a reason for that. The prudent investor will also look at the probability of the business growing (or not failing, in some cases) to determine an expectation weighted total return under a variety of different circumstances.
14. What kind of bargains are you finding in this market? Do you have any favorite sector or avoid certain areas, and why?
The market is certainly not cheap right now. Bargains are few and far between. There are some decent bargains to be found in the health care sector right now, especially in pharmaceutical distribution. Any time a strong business gets into some sort of (hopefully) temporary trouble, its price can decline and make for a bargain purchase. This was the case with Flowers Foods (FLO) several months ago, and Target (TGT) right now.
15. How do you feel about the market today? Do you see it as overvalued? What concerns you the most?
Yes, the market is clearly overvalued from a historical perspective. Ultralow interest rates are propping up market valuations right now.
The market looks very expensive but not particularly expensive when you compare it to what other investment options like bonds. What concerns me is what will happen as interest rates rise. Rising interest rates may cause the market’s multiples to revert downward.
16. What are some books that you are reading now? What is the most important lesson learned from your favorite one?
Right now, I’m reading "How to Fail at Almost Everything and Still Win Big" by Scott Adams. It isn’t an investing book per se, and the little investment advice in it certainly runs counter to how I invest personally. The most important lesson/piece of advice I’ve taken from this book is to track your energy level. Do things throughout the day to keep you interested in what you are doing and keep your energy level high to be more productive.
17. Any advice to new value investors? What should they know and what habits should they develop before they start?
My advice is to read as much as you can, and start investing, but start very small. Nearly all investors (myself included) will make some pretty dumb mistakes when they start out. If you don’t have the lion's share of your wealth invested in those mistakes, you will save substantially on your "investing tuition."
18. What are your some of your favorite value investing resources or tools? Are there any investors that you piggyback or coattail?
The 13F filings of Seth Klarman (Trades, Portfolio) and BuffettÂ are some of my favorite resources to piggyback off of. Value Line and GuruFocus are other great resources to learn more about investing.
19. Describe some of the biggest mistakes you have made value investing. What did you learn and how do you avoid the same type of mistakes today?
One that really sticks out in my mind was an investment in a Chinese company when I first was learning about value investing. It had a P/E ratio of something like 2 or 3, and was growing its earnings per share at a double-digit clip. I thought it was a phenomenal bargain – and it would’ve been, if the earnings were real. As it turns out, the company was pretty much worthless.
I learned from that experience that when you find something that is seriously mispriced you need to know whyÂ it is mispriced, and you shouldn’t be fooled by things that seem too good to be true.
20. How do you manage the mental aspect of investing when it comes to the ups, downs, crashes, corrections, and fluctuations?
Sure Dividend is a system. The system doesn’t change regardless of what the market does. Dividend growth investors have a big advantage to handle the vicissitudes of the market. You can watch your dividends grow instead of stock price changes. If a recession comes around and you can buy great businesses at bargain prices, that’s a cause to celebrate – not panic.
21. How does one avoid blowups in value investing?
There’s no way to completely avoid blow ups. Everyone makes mistakes. Even BuffettÂ has had his share of misses. You can minimize the risks of a blow up by being reasonably diversified and by investing in businesses with strong and durable competitive advantages.
22. Here's a fun one – What stock would Buffett or Benjamin Graham buy today if he were you?
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- High Yield Dividend Stocks in Gurus' Portfolio
- Top dividend stocks of Warren Buffett
- Top dividend stocks of George Soros