PRINCIPLE #5: BUY WHEN YOU HAVE MONEY IN HAND – AT THE RIGHT VALUATION
I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings put aside. There is evaluation work to be done. In order to achieve this task, I always start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio. This gives you a first glimpse of how the company is valued by the stock market. Let’s take Wells Fargo & Co (NYSE:WFC) as example:
It currently tells me that the company hasn’t been valued at 12 PE since 2013. It could be a good indication that the stock price is attractive right now. However, it just gives me some hindsight, not a clear direction.
Then, I use the double stage discount dividend model (DDM) to determine the company’s fair value along with calculating a margin of safety in case my assumptions are wrong. I use 2 different dividend growth rates; the purpose is to be able to use a dividend growth rate for the first 10 years (which is directly linked to the company’s current situation) and another one afterward (which should be more conservative). I establish my discount rate between 9% and 12% depending on the stability and risk involved with my investment. For Wells Fargo, I’ve used the following numbers:
| Input Descriptions for 15-Cell Matrix | INPUTS |
| Enter Recent Annual Dividend Payment: | $1.52 |
| Enter Expected Dividend Growth Rate Years 1-10: | 10.00% |
| Enter Expected Terminal Dividend Growth Rate: | 6.00% |
| Enter Discount Rate: | 9.00% |
This gives me the following calculation:
| Calculated Intrinsic Value OUTPUT 15-Cell Matrix | |||
| Discount Rate (Horizontal) | |||
| Margin of Safety | 8.00% | 9.00% | 10.00% |
| 20% Premium | $136.35 | $89.80 | $66.58 |
| 10% Premium | $124.98 | $82.31 | $61.03 |
| Intrinsic Value | $113.62 | $74.83 | $55.48 |
| 10% Discount | $102.26 | $67.35 | $49.93 |
| 20% Discount | $90.90 | $59.86 | $44.38 |
Source: DividendMonk Toolkit Excel Calculation Spreadsheet
By combining both methods, I can arrive at a consensus and determine if the company I’m looking to trade is at an interesting value. In this case, Wells Fargo & Co (NYSE:WFC) seems definitely undervalued. I could even use a discount rate of 10% and the company would still look like a deal.
Follow Wells Fargo & Company (NYSE:WFC)
Follow Wells Fargo & Company (NYSE:WFC)
PRINCIPLE #6: THE RATIONALE USED TO BUY IS ALSO USED TO SELL
Another important struggle most investors live is to answer this eternal question: when to buy and when to sell. To answer this question, I’m following a very simple but highly effective rule:
I buy shares of a company when my investment thesis is strong and I sell them, when my investment thesis doesn’t fit anymore.
I clearly define the reasons why I’m buying company X instead of buying Company Y or Z. An investment thesis is a combination of several good reasons why a company should post growth in the future. It usually starts with the definition of a strong economic moat (world class brand, patents, distribution network, R&D budget leaving competitors in the dust, high performing management team, new sector opening, product ecosystem or any other competitive advantage you can find).
If my thesis is proven to be right over time, I simply keep the company and benefit from the true power of dividend growth investing: dividend growth rate compounding year after year. The stronger your investment thesis is, the better your chances of keeping your holdings forever and earn compounding dividend payments.
If, by any means, my investment thesis is not valid at one point in time, there are no reasons for me to keep this company in my portfolio. This is why I sell my shares and move on. I simply review my holdings on a quarterly basis and trade accordingly. Selling a company according to the confirmation or not of your thesis shows the advantage of sometimes avoiding important value drops.
An interesting buy I made in 2013 was shares of Hasbro, Inc. (NASDAQ:HAS). This company didn’t show up on many dividend growth portfolio lists, but it sure has shown strong growth potential over the past couple of years. Here’s my investment thesis:
Hasbro, Inc. (NASDAQ:HAS) is a worldwide leader in children’s and family entertainment. It is mostly known for their numerous toy brands such as Playskool, Tonka, Milton Bradley and Parker Brothers. They are the 2nd largest toy company behind Mattel and have several trademarked franchises such as Transformers, Star Wars and Marvel action Heroes. What differentiates Hasbro, Inc. (NASDAQ:HAS) is its great ability to produce licensed products. Their recent partnerships with Disney movies is pushing the company to new highs.
